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LITHIA MOTORS INC - Quarter Report: 2018 June (Form 10-Q)



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
 

(Mark One)
 
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from       to         
 
Commission file number: 001-14733
 
LITHIA MOTORS, INC.
(Exact name of registrant as specified in its charter)
 
 
 
Oregon
 
93-0572810
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
150 N. Bartlett Street, Medford, Oregon
 
97501
(Address of principal executive offices)
 
(Zip Code)
 
Registrant's telephone number, including area code: 541-776-6401
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] (Do not check if a smaller reporting company) Smaller reporting company [ ] Emerging growth company [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class A common stock without par value
 
23,206,001
Class B common stock without par value
 
1,000,000
(Class)
 
Outstanding at July 27, 2018




LITHIA MOTORS, INC.
FORM 10-Q
INDEX 
 
PART I - FINANCIAL INFORMATION
Page
 
 
 
Item 1.
 
 
 
 
Consolidated Balance Sheets (Unaudited) - June 30, 2018 and December 31, 2017
 
 
 
 
Consolidated Statements of Operations (Unaudited) – Three and Six Months Ended June 30, 2018 and 2017
 
 
 
 
Consolidated Statements of Cash Flows (Unaudited) – Six Months Ended June 30, 2018 and 2017
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II - OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 
 
 

1



LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands)
(Unaudited)
 
 
 
June 30, 2018
 
December 31, 2017
Assets
 
 
 
 
Current Assets:
 
 
 
 
Cash and cash equivalents
 
$
29,991

 
$
57,253

Accounts receivable, net of allowance for doubtful accounts of $7,733 and $7,386
 
483,995

 
521,938

Inventories, net
 
2,333,112

 
2,132,744

Other current assets
 
46,231

 
70,847

Total Current Assets
 
2,893,329

 
2,782,782

 
 
 
 
 
Property and equipment, net of accumulated depreciation of $219,271 and $197,802
 
1,232,054

 
1,185,169

Goodwill
 
280,954

 
256,320

Franchise value
 
197,111

 
186,977

Other non-current assets
 
560,714

 
271,818

Total Assets
 
$
5,164,162

 
$
4,683,066

 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
Current Liabilities:
 
 
 
 
Floor plan notes payable
 
$
142,606

 
$
116,774

Floor plan notes payable: non-trade
 
1,875,462

 
1,802,252

Current maturities of long-term debt
 
24,098

 
18,876

Trade payables
 
115,061

 
111,362

Accrued liabilities
 
254,984

 
251,717

Total Current Liabilities
 
2,412,211

 
2,300,981

 
 
 
 
 
Long-term debt, less current maturities
 
1,295,077

 
1,028,476

Deferred revenue
 
112,601

 
103,111

Deferred income taxes
 
58,583

 
56,277

Other long-term liabilities
 
124,822

 
111,003

Total Liabilities
 
4,003,294

 
3,599,848

 
 
 
 
 
Stockholders' Equity:
 
 
 
 
Preferred stock - no par value; authorized 15,000 shares; none outstanding
 

 

Class A common stock - no par value; authorized 100,000 shares; issued and outstanding 23,433 and 23,968
 
94,386

 
149,123

Class B common stock - no par value; authorized 25,000 shares; issued and outstanding 1,000 and 1,000
 
124

 
124

Additional paid-in capital
 
43,470

 
11,309

Retained earnings
 
1,022,888

 
922,662

Total Stockholders' Equity
 
1,160,868

 
1,083,218

Total Liabilities and Stockholders' Equity
 
$
5,164,162

 
$
4,683,066

 
See accompanying condensed notes to consolidated financial statements.

2



LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
 
 
 
Three Months Ended June 30,
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
 
New vehicle
 
$
1,726,803

 
$
1,384,055

 
$
3,181,528

 
$
2,594,359

Used vehicle retail
 
804,098

 
633,635

 
1,519,672

 
1,235,858

Used vehicle wholesale
 
85,335

 
69,512

 
161,290

 
141,015

Finance and insurance
 
114,492

 
94,851

 
220,997

 
181,628

Service, body and parts
 
311,407

 
246,005

 
597,104

 
478,579

Fleet and other
 
54,402

 
38,978

 
75,625

 
71,698

Total revenues
 
3,096,537

 
2,467,036

 
5,756,216

 
4,703,137

Cost of sales:
 
 
 
 
 
 
 
 
New vehicle
 
1,625,309

 
1,303,516

 
2,993,087

 
2,443,702

Used vehicle retail
 
716,997

 
559,129

 
1,358,960

 
1,092,569

Used vehicle wholesale
 
83,409

 
67,800

 
158,438

 
137,786

Service, body and parts
 
157,700

 
123,525

 
304,989

 
242,905

Fleet and other
 
52,395

 
37,795

 
71,904

 
69,252

Total cost of sales
 
2,635,810

 
2,091,765

 
4,887,378

 
3,986,214

Gross profit
 
460,727

 
375,271

 
868,838

 
716,923

Selling, general and administrative
 
333,350

 
257,290

 
630,844

 
500,062

Depreciation and amortization
 
18,821

 
14,031

 
35,675

 
26,770

Operating income
 
108,556

 
103,950

 
202,319

 
190,091

Floor plan interest expense
 
(15,634
)
 
(9,332
)
 
(29,168
)
 
(17,384
)
Other interest expense, net
 
(13,829
)
 
(7,169
)
 
(25,635
)
 
(13,840
)
Other income, net
 
1,659

 
387

 
3,033

 
10,232

Income before income taxes
 
80,752

 
87,836

 
150,549

 
169,099

Income tax provision
 
(20,092
)
 
(34,636
)
 
(37,828
)
 
(65,172
)
Net income
 
$
60,660

 
$
53,200

 
$
112,721

 
$
103,927

 
 
 
 
 
 
 
 
 
Basic net income per share
 
$
2.45

 
$
2.12

 
$
4.52

 
$
4.14

Shares used in basic per share calculations
 
24,793

 
25,053

 
24,930

 
25,116

 
 
 
 
 
 
 
 
 
Diluted net income per share
 
$
2.44

 
$
2.12

 
$
4.50

 
$
4.13

Shares used in diluted per share calculations
 
24,882

 
25,106

 
25,028

 
25,177

 
 
 
 
 
 
 
 
 
Cash dividends paid per Class A and Class B share
 
$
0.29

 
$
0.27

 
$
0.56

 
$
0.52

 
See accompanying condensed notes to consolidated financial statements.

3



LITHIA MOTORS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
 
 
Six Months Ended June 30,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income
 
$
112,721

 
$
103,927

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
35,675

 
26,770

Stock-based compensation
 
6,837

 
5,432

(Gain) loss on disposal of other assets
 
(78
)
 
256

Loss on disposal of franchise
 
380

 

Deferred income taxes
 
345

 
(1,156
)
(Increase) decrease (net of acquisitions and dispositions):
 
 
 
 
Accounts receivable, net
 
47,915

 
70,908

Inventories
 
(35,530
)
 
(36,078
)
Other assets
 
20,588

 
479

Increase (decrease) (net of acquisitions and dispositions):
 
 
 
 
Floor plan notes payable
 
15,056

 
1,330

Trade payables
 
2,929

 
414

Accrued liabilities
 
5,463

 
(3,684
)
Other long-term liabilities and deferred revenue
 
24,030

 
9,957

Net cash provided by operating activities
 
236,331

 
178,555

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Capital expenditures
 
(72,373
)
 
(32,266
)
Proceeds from sales of assets
 
1,803

 
2,870

Cash paid for other investments
 
(7,066
)
 
(7,748
)
Cash paid for acquisitions, net of cash acquired
 
(374,664
)
 
(88,075
)
Proceeds from sales of stores
 
839

 

Net cash used in investing activities
 
(451,461
)
 
(125,219
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Borrowings (repayments) on floor plan notes payable, net: non-trade
 
85,763

 
(32,124
)
Borrowings on lines of credit
 
1,353,290

 
773,500

Repayments on lines of credit
 
(1,254,127
)
 
(808,846
)
Principal payments on long-term debt and capital leases, scheduled
 
(9,565
)
 
(8,825
)
Principal payments on long-term debt and capital leases, other
 
(5,305
)
 
(35,765
)
Proceeds from issuance of long-term debt
 
62,140

 
74,065

Payments of debt issuance costs
 
(205
)
 

Proceeds from issuance of common stock
 
4,514

 
3,519

Repurchase of common stock
 
(33,927
)
 
(24,913
)
Dividends paid
 
(13,938
)
 
(13,052
)
Payments of contingent consideration related to acquisitions
 
(772
)
 

Net cash provided by (used in) financing activities
 
187,868

 
(72,441
)
Decrease in cash and cash equivalents
 
(27,262
)
 
(19,105
)
Cash and cash equivalents at beginning of period
 
57,253

 
50,282

Cash and cash equivalents at end of period
 
$
29,991

 
$
31,177

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid during the period for interest
 
$
54,675

 
$
33,476

Cash paid during the period for income taxes, net
 
2,296

 
62,274

Floor plan debt paid in connection with store disposals
 
5,158

 

 
 
 
 
 
Supplemental schedule of non-cash activities:
 
 
 
 
Debt issued in connection with acquisitions
 
$
125,055

 
$
1,748

Debt assumed in connection with acquisitions
 
10,766

 
11,837

Issuance of Class A common stock in connection with acquisitions
 

 
2,137


 See accompanying condensed notes to consolidated financial statements.

4



LITHIA MOTORS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1. Interim Financial Statements
 
Basis of Presentation
These condensed Consolidated Financial Statements contain unaudited information as of June 30, 2018 and for the three and six-months ended June 30, 2018 and 2017. The unaudited interim financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain disclosures required by accounting principles generally accepted in the United States of America for annual financial statements are not included herein. In management’s opinion, these unaudited financial statements reflect all adjustments (which include only normal recurring adjustments) necessary for a fair presentation of the information when read in conjunction with our 2017 audited Consolidated Financial Statements and the related notes thereto. The financial information as of December 31, 2017 is derived from our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 23, 2018. The interim condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in our 2017 Annual Report on Form 10-K. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.
 
In May 2014, the Financial Accounting Standards Board ("FASB") issued accounting standards update ("ASU") 2014-09, "Revenue from Contracts with Customers," which amends the accounting guidance related to revenues. We adopted this standard utilizing a cumulative effect transition method effective January 2018. Except for the changes below, we have consistently applied the accounting policies to all periods presented in these consolidated financial statements. See Notes 2 and 13.

Reclassifications
Certain immaterial reclassifications of amounts previously reported have been made to the accompanying condensed Consolidated Financial Statements to maintain consistency and comparability between periods presented.

Note 2. Revenue Recognition

The following describes our major product lines, which represent the disaggregation of our revenues to transactions that are similar in nature, amount, timing, uncertainties and economic factors.

New Retail Vehicle and Used Retail Vehicle Sales
Revenue from the retail sale of a vehicle is recognized at a point in time, as all performance obligations are satisfied when a contract is signed by the customer, financing has been arranged or collectibility is probable and the control of the vehicle is transferred to the customer. The transaction price for a retail vehicle sale is specified in the contract with the customer and includes all cash and non-cash consideration. In a retail vehicle sale, customers often trade in their current vehicle. The trade-in is measured at its stand-alone selling price in the contract, utilizing various third-party pricing sources. There are no other non-cash forms of consideration related to retail sales. All vehicle rebates are applied to the vehicle purchase price at the time of the sale, and are therefore incorporated into the price of the contract at the time of the exchange. We do not allow the return of new or used vehicles, except where mandated by state law.

Service, Body and Parts Sales
Revenue from service, body and parts sales is recognized upon the transfer of control of the parts or service to the customer. We allow for customer returns on sales of our parts inventory up to 30 days after the sale. Most parts returns generally occur within one to two weeks from the time of sale and are not significant.

We are the obligor on our lifetime oil contracts. Revenue is allocated to these performance obligations and is recognized over time as services are provided to the customer. The amount of revenue recognized is calculated, net of cancellations, using an input method, which most closely depicts performance of the contracts. Our contract liability balances were $138.5 million and $126.1 million as of June 30, 2018 and December 31, 2017, respectively; and we recognized $6.0 million and $11.7 million of revenue in the three and six months ended June 30, 2018, related to our opening contract liability balance.

Finance and Insurance Sales
Revenue from finance and insurance sales is recognized, net of estimated charge-backs, at the time of the sale of the related vehicle. As a part of the vehicle sale, we seek to arrange financing for customers and sell a variety of add-ons, such as extended warranty service contracts. These products are inherently attached to the governing vehicle and performance of the obligation cannot be performed without the underlying sale of the vehicle. We act as an agent in the sale of these contracts as the pricing is set by the

5



third-party provider and our commission is preset. A portion of the transaction price related to sales of finance and insurance contracts is considered variable consideration and is estimated and recognized upon the sale of the contract under the new standard. We recognized a $9.2 million asset associated with future estimated variable consideration on January 1, 2018 related to contracts sold on or before December 31, 2017. Our contract asset balance was $9.2 million as of June 30, 2018 and is included in trade receivables and other non-current assets.

Note 3. Accounts Receivable and Contract Assets

Accounts receivable consisted of the following (in thousands):
 
 
June 30, 2018
 
December 31, 2017
Contracts in transit
 
$
239,698

 
$
286,578

Trade receivables
 
51,403

 
45,895

Vehicle receivables
 
57,795

 
60,022

Manufacturer receivables
 
97,173

 
96,141

Auto loan receivables
 
67,402

 
75,052

Other receivables
 
4,920

 
14,634

 
 
518,391


578,322

Less: Allowance for doubtful accounts
 
(7,733
)
 
(7,386
)
Less: Long-term portion of accounts receivable, net
 
(26,663
)
 
(48,998
)
Total accounts receivable, net
 
$
483,995


$
521,938


Accounts receivable classifications include the following:

Contracts in transit are receivables from various lenders for the financing of vehicles that we have arranged on behalf of the customer and are typically received approximately ten days after selling a vehicle.
Trade receivables are comprised of amounts due from customers for open charge accounts, lenders for the commissions earned on financing and others for commissions earned on service contracts and insurance products.
Vehicle receivables represent receivables for the portion of the vehicle sales price paid directly by the customer.
Manufacturer receivables represent amounts due from manufacturers, including holdbacks, rebates, incentives and warranty claims.
Auto loan receivables include amounts due from customers related to retail sales of vehicles and certain finance and insurance products.

Interest income on auto loan receivables is recognized based on the contractual terms of each loan and is accrued until repayment, charge-off, or repossession. Direct costs associated with loan originations are capitalized and expensed as an offset to interest income when recognized on the loans. All other receivables are recorded at invoice and do not bear interest until they are 60 days past due.

The allowance for doubtful accounts is estimated based on our historical write-off experience and is reviewed monthly. Consideration is given to recent delinquency trends and recovery rates. Account balances are charged against the allowance after all appropriate means of collection have been exhausted and the potential for recovery is considered remote. The annual activity for charges and subsequent recoveries is immaterial.

The long-term portion of accounts receivable was included as a component of other non-current assets in the Consolidated Balance Sheets.

Note 4. Inventories

The components of inventories, net, consisted of the following (in thousands):
 
 
June 30, 2018
 
December 31, 2017
New vehicles
 
$
1,694,026

 
$
1,553,751

Used vehicles
 
553,248

 
500,011

Parts and accessories
 
85,838

 
78,982

Total inventories
 
$
2,333,112

 
$
2,132,744


6



Note 5. Goodwill and Franchise Value

The changes in the carrying amounts of goodwill are as follows (in thousands):
 
 
Domestic
 
Import
 
Luxury
 
Consolidated
Balance as of December 31, 2016 ¹
 
$
114,839

 
$
106,179

 
$
38,381

 
$
259,399

Adjustments to purchase price allocations 2
 
(817
)
 
(1,006
)
 
(391
)
 
(2,214
)
Reductions through divestitures
 

 
(865
)
 

 
(865
)
Balance as of December 31, 2017 ¹
 
114,022

 
104,308

 
37,990

 
256,320

Adjustments to purchase price allocations 3
 
7,726

 
15,674

 
1,271

 
24,671

Reductions through divestitures
 

 
(37
)
 

 
(37
)
Balance as of June 30, 2018 1, 4
 
$
121,748

 
$
119,945

 
$
39,261

 
$
280,954

1 Net of accumulated impairment losses of $299.3 million recorded during the year ended December 31, 2008.
2 Our purchase price allocation for the acquisition of the Carbone Auto Group was finalized in the third quarter of 2017. As a result, we reclassified $2.2 million of value from goodwill to franchise value.
3 Our purchase price allocation for the acquisition of the Baierl Auto Group was finalized in the second quarter of 2018. As a result, we added $24.7 million of goodwill.
4 Our purchase price allocation is preliminary for the acquisitions of the Downtown LA Auto Group, Albany CJD Fiat, Crater Lake Ford Lincoln, Crater Lake Mazda, Ray Laks Honda, Ray Laks Acura, Day Auto Group, Prestige Auto Group, Broadway Ford, and Buhler Ford and the associated goodwill has not been allocated to each of our segments. See also Note 11.

The changes in the carrying amounts of franchise value are as follows (in thousands):
 
Franchise Value
Balance as of December 31, 2016
$
184,268

Additions through acquisitions
495

Adjustments to purchase price allocations 1
2,214

Balance as of December 31, 2017
186,977

Adjustments to purchase price allocations 2
10,134

Balance as of June 30, 2018 3
$
197,111

1 Our purchase price allocation for the acquisition of the Carbone Auto Group was finalized in the third quarter of 2017, resulting in a reclassification of $2.2 million from goodwill to franchise value.
2 Our purchase price allocation for the acquisition of the Baierl Auto Group was finalized in the second quarter of 2018. As a result, we added $10.1 million of franchise value.
3Our purchase price allocation is preliminary for the acquisitions of the Downtown LA Auto Group, Albany CJD Fiat, Crater Lake Ford Lincoln, Crater Lake Mazda, Ray Laks Honda, Ray Laks Acura, Day Auto Group, Prestige Auto Group, Broadway Ford, and Buhler Ford and have not been included in the above franchise value additions. See also Note 11.


7



Note 6. Credit Facilities and Long-term Debt

Below is a summary of our outstanding balances on credit facilities and long-term debt (in thousands):
(Dollars in thousands)
 
June 30, 2018
 
December 31, 2017
Floor plan notes payable: non-trade
 
$
1,875,462

 
$
1,802,252

Floor plan notes payable
 
142,606

 
116,774

Total floor plan debt
 
$
2,018,068

 
$
1,919,026

 
 
 
 
 
Used vehicle inventory financing facility
 
$
50,000

 
$
177,222

Revolving lines of credit
 
320,953

 
94,568

Real estate mortgages
 
642,602

 
469,969

5.25% Senior Notes due 2025
 
300,000

 
300,000

Other debt
 
12,195

 
12,512

Total long-term debt outstanding
 
1,325,750

 
1,054,271

Less: unamortized debt issuance costs
 
(6,575
)
 
(6,919
)
Less: current maturities (net of current debt issuance costs)
 
(24,098
)
 
(18,876
)
Long-term debt
 
$
1,295,077

 
$
1,028,476


Credit Facility
Effective June 25, 2018, we amended our syndicated credit facility, which is comprised of 20 financial institutions, including seven manufacturer-affiliated finance companies. Prior to this amendment, the credit facility, with an aggregate total financing commitment of $2.4 billion, would have matured in August 2022. With this amendment, the aggregate total financing commitment has been increased to $2.6 billion and the term of the credit facility has been extended to July 2023.

The total commitment is allocated as $135 million to used vehicle inventory floor plan financing, $450 million to revolving loans for acquisitions and other general corporate purposes, and the remaining $2.0 billion for new vehicle inventory floor plan financing. We have the option to reallocate the commitments, provided that the used vehicle inventory floor plan financing commitment does not exceed 16.5% of aggregate commitments, the revolving loan commitment does not exceed 18.75% of aggregate commitments, and the sum of these commitments plus the new vehicle inventory floor plan financing commitment does not exceed the aggregate total financing commitment of $2.6 billion. Additionally, we may request an increase in the aggregate new vehicle floor plan commitment of up to $400 million provided that the aggregate commitment does not exceed $3.0 billion. All borrowings from, and repayments to, our lending group are presented in the Consolidated Statements of Cash Flows as financing activities.

Our obligations under our revolving syndicated credit facility are secured by a substantial amount of our assets, including our inventory (including new and used vehicles, parts and accessories), equipment, accounts (and other rights to payment) and our equity interests in certain of our subsidiaries. Under our revolving syndicated credit facility, our obligations relating to new vehicle floor plan loans are secured only by collateral owned by borrowers of new vehicle floor plan loans under the credit facility.

We have the ability to deposit up to $50 million in cash in Principal Reduction (PR) accounts associated with our new vehicle inventory floor plan commitment. The PR accounts are recognized as offsetting credits against outstanding amounts on our new vehicle floor plan commitment and would reduce interest expense associated with the outstanding principal balance. As of June 30, 2018, we had no balances in our PR accounts.

If the outstanding principal balance on our new vehicle inventory floor plan commitment, plus requests on any day, exceeds 95% of the loan commitment, a portion of the revolving line of credit must be reserved. The reserve amount is equal to the lesser of $15.0 million or the maximum revolving line of credit commitment less the outstanding balance on the line less outstanding letters of credit. The reserve amount will decrease the revolving line of credit availability and may be used to repay the new vehicle floor plan commitment balance.

The interest rate on the credit facility, as amended, varies based on the type of debt, with the rate of one-month LIBOR plus 1.25% for new vehicle floor plan financing, one-month LIBOR plus 1.50% for used vehicle floor plan financing and a variable interest rate on the revolving financing ranging from the one-month LIBOR plus 1.25% to 2.25% depending on our leverage ratio. The annual interest rate associated with our new vehicle floor plan commitment was 3.34% at June 30, 2018. The annual interest rate associated with our used vehicle inventory financing facility and our revolving line of credit was 3.59% at June 30, 2018.


8




5.25% Senior Notes Due 2025
On July 24, 2017, we issued $300 million in aggregate principal amount of 5.25% Senior Notes due 2025 ("the Notes") to eligible purchasers in a private placement under Rule 144A and Regulation S of the Securities Act of 1933. Interest accrues on the Notes from July 24, 2017 and is payable semiannually on February 1 and August 1. The first interest payment was paid on February 1, 2018. We may redeem the Notes in whole or in part at any time prior to August 1, 2020 at a price equal to 100% of the principal amount plus a make-whole premium set forth in the Indenture and accrued and unpaid interest. After August 1, 2020, we may redeem some or all of the Notes subject to the redemption prices set forth in the Indenture. If we experience specific kinds of changes of control, as described in the Indenture, we must offer to repurchase the Notes at 101% of their principal amount plus accrued and unpaid interest to the date of purchase.

Note 7. Stockholders’ Equity

Repurchases of Class A Common Stock
Repurchases of our Class A Common Stock occurred under a repurchase authorization granted by our Board of Directors and related to shares withheld as part of the vesting of restricted stock units ("RSUs"). In February 2016, our Board of Directors authorized the repurchase of up to $250 million of our Class A common stock. Share repurchases under this authorization were as follows:
 
 
Repurchases Occurring in the Six Months Ended June 30, 2018
 
Cumulative Repurchases as of June 30, 2018
 
 
Shares
 
Average Price
 
Shares
 
Average Price
2016 Share Repurchase Authorization
 
640,586

 
$
99.89

 
1,683,311

 
$
89.96


As of June 30, 2018, we had $98.6 million available for repurchases pursuant to our 2016 share repurchase authorization.

In addition, during the first six months of 2018, we repurchased 29,710 shares at an average price of $112.36 per share, for a total of $3.3 million, related to tax withholdings associated with the vesting of RSUs. The repurchase of shares related to tax withholdings associated with stock awards does not reduce the number of shares available for repurchase as approved by our Board of Directors.

Note 8. Fair Value Measurements

Fair Value Disclosures for Financial Assets and Liabilities
We determined the carrying value of cash equivalents, accounts receivable, trade payables, accrued liabilities and short-term borrowings approximate their fair values because of the nature of their terms and current market rates of these instruments. We believe the carrying value of our variable rate debt approximates fair value.
 
We have fixed rate debt primarily consisting of amounts outstanding under our senior notes and real estate mortgages. We calculated the estimated fair value of the senior notes using quoted prices for the identical liability (Level 1) and calculated the estimated fair value of the fixed rate real estate mortgages using a discounted cash flow methodology with estimated current interest rates based on a similar risk profile and duration (Level 2). The fixed cash flows are discounted and summed to compute the fair value of the debt. As of June 30, 2018, our real estate mortgages and other debt, which includes capital leases, had maturity dates between September 27, 2019 and December 31, 2050.

There were no changes to our valuation techniques during the six-month period ended June 30, 2018.


9



A summary of the aggregate carrying values, excluding unamortized debt issuance cost, and fair values of our long-term fixed interest rate debt is as follows (in thousands):
 
 
June 30, 2018
 
December 31, 2017
Carrying value
 
 
 
 
5.25% Senior Notes due 2025
 
$
300,000

 
$
300,000

Real Estate Mortgages and Other Debt
 
451,950

 
376,880

 
 
$
751,950


$
676,880

Fair value
 
 
 
 
5.25% Senior Notes due 2025
 
$
291,750

 
$
312,750

Real Estate Mortgages and Other Debt
 
450,686

 
385,337

 
 
$
742,436

 
$
698,087


Note 9. Net Income Per Share of Class A and Class B Common Stock

We compute net income per share of Class A and Class B common stock using the two-class method. Under this method, basic net income per share is computed using the weighted average number of common shares outstanding during the period excluding common shares underlying equity awards that are unvested or subject to forfeiture. Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the common shares issuable upon the net exercise of stock options and unvested RSUs and is reflected in diluted earnings per share by application of the treasury stock method. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while the diluted net income per share of Class B common stock does not assume the conversion of those shares.
 
Except with respect to voting and transfer rights, the rights of the holders of our Class A and Class B common stock are identical. Under our Articles of Incorporation, the Class A and Class B common stock share equally in any dividends, liquidation proceeds or other distribution with respect to our common stock and the Articles of Incorporation can only be amended by a vote of the shareholders. Additionally, Oregon law provides that amendments to our Articles of Incorporation that would adversely alter the rights, powers or preferences of a given class of stock, must be approved by the class of stock adversely affected by the proposed amendment. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares as if the earnings for the year had been distributed. Because the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis.


10



Following is a reconciliation of net income and weighted average shares used for our basic earnings per share (“EPS”) and diluted EPS (in thousands, except per share amounts):
Three Months Ended June 30,
 
2018
 
2017
(in thousands, except per share data)
 
Class A
 
Class B
 
Class A
 
Class B
Net income applicable to common stockholders - basic
 
$
58,213

 
$
2,447

 
$
50,520

 
$
2,680

Reallocation of net income as a result of conversion of dilutive stock options
 
1

 
(1
)
 
1

 
(1
)
Reallocation of net income due to conversion of Class B to Class A common shares outstanding
 
289

 

 
340

 

Conversion of Class B common shares into Class A common shares
 
2,149

 

 
2,334

 

Effect of dilutive stock options on net income
 
8

 
(8
)
 
5

 
(5
)
Net income applicable to common stockholders - diluted
 
$
60,660

 
$
2,438

 
$
53,200

 
$
2,674

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
 
23,793

 
1,000

 
23,791

 
1,262

Conversion of Class B common shares into Class A common shares
 
1,000

 

 
1,262

 

Effect of dilutive stock options on weighted average common shares
 
89

 

 
53

 

Weighted average common shares outstanding – diluted
 
24,882

 
1,000

 
25,106

 
1,262

 
 
 
 
 
 
 
 
 
Net income per common share - basic
 
$
2.45

 
$
2.45

 
$
2.12

 
$
2.12

Net income per common share - diluted
 
$
2.44

 
$
2.44

 
$
2.12

 
$
2.12

  
Three Months Ended June 30,
 
2018
 
2017
Diluted EPS
 
Class A
 
Class B
 
Class A
 
Class B
Antidilutive Securities
 
 
 
 
 
 
 
 
Shares issuable pursuant to stock options not included since they were antidilutive
 
30

 

 
22

 



11



Six Months Ended June 30,
 
2018
 
2017
(in thousands, except per share data)
 
Class A
 
Class B
 
Class A
 
Class B
Net income applicable to common stockholders - basic
 
$
108,199

 
$
4,522

 
$
98,337

 
$
5,590

Reallocation of distributed net income as a result of conversion of dilutive stock options
 
2

 
(2
)
 
2

 
(2
)
Reallocation of distributed net income due to conversion of Class B to Class A common shares outstanding
 
557

 

 
700

 

Conversion of Class B common shares into Class A common shares
 
3,947

 

 
4,876

 

Effect of dilutive stock options on net income
 
16

 
(16
)
 
12

 
(12
)
Net income applicable to common stockholders - diluted
 
$
112,721

 
$
4,504

 
$
103,927

 
$
5,576

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding – basic
 
23,930

 
1,000

 
23,765

 
1,351

Conversion of Class B common shares into Class A common shares
 
1,000

 

 
1,351

 

Effect of employee stock purchases and restricted stock units on weighted average common shares
 
98

 

 
61

 

Weighted average common shares outstanding – diluted
 
25,028

 
1,000

 
25,177

 
1,351

 
 
 
 
 
 
 
 
 
Net income per common share - basic
 
$
4.52

 
$
4.52

 
$
4.14

 
$
4.14

Net income per common share - diluted
 
$
4.50

 
$
4.50

 
$
4.13

 
$
4.13

Six Months Ended June 30,
 
2018
 
2017
Diluted EPS
 
Class A
 
Class B
 
Class A
 
Class B
Antidilutive Securities
 
 
 
 
 
 
 
 
Shares issuable pursuant to stock options not included since they were antidilutive
 
56

 

 
11

 


Note 10. Segments

While we have determined that each individual store is a reporting unit, we have aggregated our reporting units into three reportable segments based on their economic similarities: Domestic, Import and Luxury.

Our Domestic segment is comprised of retail automotive franchises that sell new vehicles manufactured by Chrysler, General Motors and Ford. Our Import segment is comprised of retail automotive franchises that sell new vehicles manufactured primarily by Honda, Toyota, Subaru, Nissan and Volkswagen. Our Luxury segment is comprised of retail automotive franchises that sell new vehicles manufactured primarily by BMW, Mercedes and Lexus. The franchises in each segment also sell used vehicles, parts and automotive services, as well as automotive finance and insurance products.

Corporate and other revenue and income includes the results of operations of our stand-alone body shops offset by unallocated corporate overhead expenses, such as corporate personnel costs, and certain unallocated reserve and elimination adjustments. Additionally, certain internal corporate expense allocations increase segment income for Corporate and other while decreasing segment income for the other reportable segments. These internal corporate expense allocations are used to increase comparability of our dealerships and reflect the capital burden a stand-alone dealership would experience. Examples of these internal allocations include internal rent expense, internal floor plan financing charges, and internal fees charged to offset employees within our corporate headquarters who perform certain dealership functions.

We define our chief operating decision maker (“CODM”) to be certain members of our executive management group. Historical and forecasted operational performance are evaluated on a store-by-store basis and on a consolidated basis by the CODM. We derive the operating results of the segments directly from our internal management reporting system. The accounting policies used to derive segment results are substantially the same as those used to determine our consolidated results, except for the internal allocation within Corporate and other discussed above. Our CODM measures the performance of each operating segment based on several metrics, including earnings from operations, and uses these results, in part, to evaluate the performance of, and to allocate resources to, each of the operating segments.


12



Certain financial information on a segment basis is as follows (in thousands):
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 

 
 

 
 

 
 

Domestic
 
 
 
 
 
 
 
 
New vehicle
 
$
597,596

 
$
528,649

 
$
1,111,125

 
$
1,013,906

Used vehicle retail
 
283,408

 
251,214

 
548,235

 
496,212

Used vehicle wholesale
 
33,913

 
30,700

 
67,519

 
62,986

Finance and insurance
 
43,083

 
37,354

 
83,083

 
73,562

Service, body and parts
 
113,472

 
96,515

 
220,614

 
189,917

Fleet and other
 
23,596

 
10,517

 
35,109

 
18,124

 
 
1,095,068

 
954,949

 
2,065,685

 
1,854,707

Import
 
 
 
 
 
 
 
 
New vehicle
 
771,987

 
643,404

 
1,439,590

 
1,195,286

Used vehicle retail
 
335,629

 
269,512

 
643,317

 
516,788

Used vehicle wholesale
 
30,983

 
27,283

 
59,178

 
54,120

Finance and insurance
 
54,866

 
45,282

 
106,562

 
85,855

Service, body and parts
 
116,386

 
96,964

 
226,041

 
185,626

Fleet and other
 
12,879

 
12,794

 
18,475

 
29,036

 
 
1,322,730

 
1,095,239

 
2,493,163

 
2,066,711

Luxury
 
 
 
 
 
 
 
 
New vehicle
 
361,913

 
220,388

 
640,434

 
396,705

Used vehicle retail
 
184,941

 
112,032

 
327,845

 
222,637

Used vehicle wholesale
 
20,263

 
11,473

 
34,463

 
23,696

Finance and insurance
 
15,934

 
9,525

 
28,185

 
17,519

Service, body and parts
 
76,883

 
50,326

 
141,676

 
98,358

Fleet and other
 
17,596

 
15,419

 
21,422

 
24,052

 
 
677,530

 
419,163

 
1,194,025

 
782,967

 
 
3,095,328


2,469,351


5,752,873

 
4,704,385

Corporate and other
 
1,209

 
(2,315
)
 
3,343

 
(1,248
)
 
 
$
3,096,537


$
2,467,036


$
5,756,216

 
$
4,703,137

Segment income1:
 
 

 
 

 
 

 
 

Domestic
 
$
28,545

 
$
27,857

 
$
54,163

 
$
53,299

Import
 
30,244

 
32,238

 
53,265

 
54,411

Luxury
 
11,939

 
10,315

 
18,826

 
15,027

 
 
70,728


70,410


126,254

 
122,737

Corporate and other
 
41,015

 
38,239

 
82,572

 
76,740

Depreciation and amortization
 
(18,821
)
 
(14,031
)
 
(35,675
)
 
(26,770
)
Other interest expense
 
(13,829
)
 
(7,169
)
 
(25,635
)
 
(13,840
)
Other income, net
 
1,659

 
387

 
3,033

 
10,232

Income before income taxes
 
$
80,752


$
87,836


$
150,549

 
$
169,099

1Segment income for each of the segments is defined as income before income taxes, depreciation and amortization, other interest expense and other income, net.

 

13



 
 
June 30, 2018
 
December 31, 2017
Total assets:
 
 
 
 
Domestic
 
$
1,380,823

 
$
1,224,276

Import
 
1,244,218

 
1,032,665

Luxury
 
690,774

 
604,023

Corporate and other
 
1,848,347

 
1,822,102

 
 
$
5,164,162

 
$
4,683,066


Note 11. Acquisitions

In the first six months of 2018, we completed the following acquisitions:
On January 15, 2018, Ray Laks Honda in Orchard Park, New York and Ray Laks Acura in Buffalo, New York.
On February 26, 2018, Day Auto Group, a seven store platform based in Pennsylvania.
On March 1, 2018, Prestige Auto Group, a six store platform based in New Jersey and New York.
On April 2, 2018, Broadway Ford in Idaho Falls, Idaho.
On April 23, 2018, Buhler Ford in Eatontown, New Jersey.

Revenue and net loss contributed by the 2018 acquisitions subsequent to the date of acquisition were as follows (in thousands):
Revenue
$
360,442

Net loss
$
(946
)

In 2017, we completed the following acquisitions:
On May 1, 2017, we acquired Baierl Auto Group, an eight store platform based in Pennsylvania.
On August 7, 2017, we acquired Downtown LA ("DTLA") Auto Group, a seven store platform based in California.
On November 11, 2017, we acquired Albany CJD Fiat in Albany, New York.
On November 15, 2017, we acquired Crater Lake Ford Lincoln and Crater Lake Mazda in Medford, Oregon.

All acquisitions were accounted for as business combinations under the acquisition method of accounting. The results of operations of the acquired stores are included in our Consolidated Financial Statements from the date of acquisition.
 
The following tables summarize the consideration paid for the 2018 acquisitions and the amount of identified assets acquired and liabilities assumed as of the acquisition date (in thousands):
 
 
Consideration
Cash paid, net of cash acquired
 
$
374,664

Debt issued
 
125,055

 
 
$
499,719


The purchase price allocations for the Downtown LA Auto Group, Albany CJD Fiat, Crater Lake Ford Lincoln, Crater Lake Mazda, Ray Laks Honda, Ray Laks Acura, Day Auto Group, Prestige Auto Group, Broadway Ford, and Buhler Ford acquisitions are preliminary and we have not obtained and evaluated all of the detailed information necessary to finalize the opening balance sheet amounts in all respects. We recorded the purchase price allocations based upon information that is currently available. Unallocated items are recorded as a component of other non-current assets in the Consolidated Balance Sheets.
 
 
Assets Acquired and Liabilities Assumed
Accounts receivable
 
$
732

Inventories, net
 
180,035

Property and equipment, net
 
9,850

Other non-current assets
 
322,006

Floor plan notes payable
 
(10,776
)
Other long-term liabilities
 
(2,128
)
 
 
$
499,719



14



In the three and six-month periods ended June 30, 2018, we recorded $3.3 million and $4.2 million in acquisition related expenses as a component of selling, general and administrative expense. Comparatively, we recorded $2.1 million and $2.2 million, respectively, of acquisition related expenses in the same periods in 2017.
 
The following unaudited proforma summary presents consolidated information as if all acquisitions in the three and six-month periods ended June 30, 2018 and 2017 had occurred on January 1, 2017 (in thousands, except per share amounts):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Revenue
 
$
3,101,600

 
$
3,054,987

 
$
5,956,427

 
$
5,906,047

Net income
 
60,678

 
56,126

 
111,419

 
109,162

Basic net income per share
 
2.45

 
2.24

 
4.47

 
4.35

Diluted net income per share
 
2.44

 
2.24

 
4.45

 
4.34

 
These amounts have been calculated by applying our accounting policies and estimates. The results of the acquired stores have been adjusted to reflect the following: depreciation on a straight-line basis over the expected lives for property and equipment; accounting for inventory on a specific identification method; and recognition of interest expense for real estate financing related to stores where we purchased the facility. No nonrecurring proforma adjustments directly attributable to the acquisitions are included in the reported proforma revenues and earnings.

Note 12. Recent Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, "Leases." ASU 2016-02 increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosing key information about leasing arrangements. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods. We will adopt this accounting standard update effective January 1, 2019. A modified retrospective transition approach is required for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We have both real estate leases and equipment leases that will be impacted by the new guidance. We continue to evaluate the effect this pronouncement will have on our consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment." ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under the updated standard, an entity should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, if applicable. The loss recognized should not exceed the total amount of goodwill allocated to the reporting unit. The same impairment test also applies to any reporting unit with a zero or negative carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. ASU 2017-04 is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2019, on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. We do not expect the adoption of ASU 2017-04 to have a material effect on our financial position, results of operations or cash flows.


15



Note 13. Changes in Accounting Policies

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers," which amends the accounting guidance related to revenues. This amendment replaced most of the existing revenue recognition guidance. The new standard, as amended in July 2015, is effective for fiscal years beginning after December 15, 2017, and interim periods therein. The standard permits the use of either the retrospective or cumulative effect transition method. We adopted this standard utilizing a cumulative effect transition method effective January 2018. While the adoption of the new standard did not have a significant effect on earnings or on the timing of our most significant types of transactions, we made the following changes to our revenue policies:

A portion of the transaction price related to sales of finance and insurance contracts is considered variable consideration and subject to accelerated recognition under the new standard. Accordingly, we recognized a $9.2 million asset associated with future estimated variable consideration and a net of tax increase to retained earnings of $6.5 million. We do not believe there will be a significant impact to future revenue recognized.

The adoption of the new standard clarifies the determination and capitalization of direct costs incurred. As a result, we reassessed the method used to capitalize and amortize direct costs associated with the sale of lifetime lube, oil and filter contracts, which resulted in a $7.2 million reduction in prepaid commissions and a net of tax $5.1 million reduction to retained earnings.

These changes had an immaterial effect on our Consolidated Statements of Operations and the following impact on our Consolidated Balance Sheets (in thousands):
 
 
As Reported
 
 
 
Balances without the adoption of Topic 606
Impact on Consolidated Balance Sheets
 
June 30, 2018
 
Adjustments
 
Accounts receivable, net
 
$
483,995

 
$
(3,631
)
 
$
480,364

Other current assets
 
46,231

 
(1,237
)
 
44,994

Other non-current assets
 
560,714

 
3,653

 
564,367

Total Assets
 
5,164,162

 
(1,215
)
 
5,162,947

Accrued Liabilities
 
254,984

 
208

 
255,192

Deferred income taxes
 
58,583

 
(599
)
 
57,984

Total Liabilities
 
4,003,294

 
(391
)
 
4,002,903

Retained earnings
 
1,022,888

 
(824
)
 
1,022,064

Total Liabilities and Stockholders' Equity
 
5,164,162

 
(1,215
)
 
5,162,947


Note 14. Subsequent Events
 
Common Stock Dividend
On July 23, 2018, our Board of Directors approved a dividend of $0.29 per share on our Class A and Class B common stock related to our second quarter 2018 financial results. The dividend will total approximately $7.0 million and will be paid on August 29, 2018 to shareholders of record on August 15, 2018.

Repurchase of Class A Common Stock
Since June 30, 2018, we repurchased 226,910 shares at a weighted average price of $86.65 per share and as of July 27, 2018, under our existing share repurchase authorization, $78.9 million million remained available for share repurchases.

16



Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements and Risk Factors
Certain statements under the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” and elsewhere in this Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Generally, you can identify forward-looking statements by terms such as “project”, “outlook,” “target”, “may,” “will,” “would,” “should,” “seek,” “expect,” “plan,” “intend,” “forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “likely,” “goal,” “strategy,” “future,” “maintain,” and “continue” or the negative of these terms or other comparable terms. Examples of forward-looking statements in this Form 10-Q include, among others, statements we make regarding:
Future market conditions, including anticipated national new car sales levels;
Expected operating results, such as improved store performance; continued improvement of SG&A as a percentage of gross profit and all projections;
Anticipated continued success of acquisitions;
Anticipated ability to capture additional market share;
Anticipated ability to find accretive acquisitions;
Anticipated additions of dealership locations to our portfolio in the future;
Anticipated availability of liquidity from our unfinanced operating real estate; and
Anticipated levels of capital expenditures in the future.
 
The forward-looking statements contained in this Form 10-Q involve known and unknown risks, uncertainties and situations that may cause our actual results to materially differ from the results expressed or implied by these statements. Certain important factors that could cause actual results to differ from our expectations are discussed in Part II - Other Information, Item 1A in this Form 10-Q and in the Risk Factors section of our 2017 Annual Report on Form 10-K, as supplemented and amended from time to time in Quarterly Reports on Form 10-Q and our other filings with the Securities and Exchange Commission. Such factors include, but are not limited to:
Changing economic conditions, including changes in consumer demand, the availability of credit, fuel prices and interest rates;
Natural disasters, adverse weather conditions, acts of God or other incidents;
Increasing competition in our industry;
Adverse conditions affecting one or more key manufacturers whose brands we sell;
Availability of manufacturer incentives, warranty and other promotional programs;
Manufacturers relationships and our ability to renew or enter into new franchise agreements on acceptable terms;
Changes in laws and regulations;
Breaches in our data security systems or in systems used by our vendor partners; and
Our ability to acquire and successfully integrate additional stores
 
By their nature, forward-looking statements involve risks and uncertainties because they relate to events that depend on circumstances that may or may not occur in the future. You should not place undue reliance on these forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. We assume no obligation to update or revise any forward-looking statement.
 
Overview
Lithia Motors, Inc. is one of the largest providers of personal transportation solutions in the United States and is among the fastest growing companies in the Fortune 500 (#294-2018). Consumers can buy, sell and service vehicles digitally or through our 188 coast to coast locations. Our mission statement, Growth Powered by People, drives us to continuously improve and to give back to our communities.

We believe that the fragmented nature of the automotive dealership sector provides us with the opportunity to achieve growth through consolidation. In 2017, the top ten automotive retailers, as reported by Automotive News, represented approximately 7% of the stores in the United States. Our dealerships are located across the United States. We seek domestic, import and luxury franchises in cities ranging from mid-sized regional markets to metropolitan markets. We evaluate all brands for expansion opportunities provided the market is large enough to support adequate new vehicle sales to justify the required capital investment. Our acquisition strategy has been to acquire dealerships at prices that meet our internal investment targets and, through the application of our centralized operating structure, leverage costs and improve store profitability. We believe our disciplined approach and the current economic environment provides us with attractive acquisition opportunities.
 
We also believe that we can continue to improve operations at our existing stores. By promoting entrepreneurial leadership within our general and department managers, we strive for continuous improvement to drive sales and capture market share in our local

17



markets. Our goal is to retail an average of 85 used vehicles per store per month and we believe we can make additional improvements in our used vehicle sales performance by offering lower-priced value vehicles and selling brands other than the new vehicle franchise at each location. Our service, body and parts operations provide important repeat business for our stores. We continue to grow this business through increased marketing efforts, competitive pricing on routine maintenance items and diverse commodity product offerings.

During the second quarter of 2018, we continued to integrate recently acquired stores. The second quarter experienced strong performance in revenue and gross profit growth contributed by our recent acquisitions. Newly acquired stores generally have a lower operating efficiency than our other stores and can negatively impact our operating margin. We continue to focus on accelerating the integration of acquired stores to leverage our cost structure and increase incremental profitability.

Key Revenue and Gross Profit Metrics
Key performance metrics for revenue and gross profit were as follows (dollars in thousands):

Three Months Ended
June 30, 2018
 
Revenues
 
Percent of
Total Revenues
 
Gross Profit
 
Gross Profit
Margin
 
Percent of Total
Gross Profit
New vehicle
 
$
1,726,803

 
55.8
%
 
$
101,494

 
5.9
%
 
22.0
%
Used vehicle retail
 
804,098

 
26.0

 
87,101

 
10.8

 
18.9

Used vehicle wholesale
 
85,335

 
2.8

 
1,926

 
2.3

 
0.4

Finance and insurance 1
 
114,492

 
3.7

 
114,492

 
100.0

 
24.9

Service, body and parts
 
311,407

 
10.1

 
153,707

 
49.4

 
33.4

Fleet and other
 
54,402

 
1.6

 
2,007

 
3.7

 
0.4

 
 
$
3,096,537

 
100.0
%
 
$
460,727

 
14.9
%
 
100.0
%
 
Three Months Ended
June 30, 2017
 
Revenues
 
Percent of
Total Revenues
 
Gross Profit
 
Gross Profit
Margin
 
Percent of Total
Gross Profit
New vehicle
 
$
1,384,055

 
56.1
%
 
$
80,539

 
5.8
%
 
21.5
%
Used vehicle retail
 
633,635

 
25.7

 
74,506

 
11.8

 
19.9

Used vehicle wholesale
 
69,512

 
2.8

 
1,712

 
2.5

 
0.5

Finance and insurance 1
 
94,851

 
3.8

 
94,851

 
100.0

 
25.3

Service, body and parts
 
246,005

 
10.0

 
122,480

 
49.8

 
32.6

Fleet and other
 
38,978

 
1.6

 
1,183

 
3.0

 
0.2

 
 
$
2,467,036

 
100.0
%
 
$
375,271

 
15.2
%
 
100.0
%
1 Commissions reported net of anticipated cancellations.
Six Months Ended
June 30, 2018
 
Revenues
 
Percent of
Total Revenues
 
Gross Profit
 
Gross Profit
Margin
 
Percent of Total
Gross Profit
New vehicle
 
$
3,181,528

 
55.3
%
 
$
188,441

 
5.9
%
 
21.7
%
Used vehicle retail
 
1,519,672

 
26.4

 
160,712

 
10.6

 
18.5

Used vehicle wholesale
 
161,290

 
2.8

 
2,852

 
1.8

 
0.3

Finance and insurance 1
 
220,997

 
3.8

 
220,997

 
100.0

 
25.4

Service, body and parts
 
597,104

 
10.4

 
292,115

 
48.9

 
33.6

Fleet and other
 
75,625

 
1.3

 
3,721

 
4.9

 
0.5

 
 
$
5,756,216

 
100.0
%
 
$
868,838

 
15.1
%
 
100.0
%
 

18



Six Months Ended
June 30, 2017
 
Revenues
 
Percent of
Total Revenues
 
Gross Profit
 
Gross Profit
Margin
 
Percent of Total
Gross Profit
New vehicle
 
$
2,594,359

 
55.2
%
 
$
150,657

 
5.8
%
 
21.0
%
Used vehicle retail
 
1,235,858

 
26.3

 
143,289

 
11.6

 
20.0

Used vehicle wholesale
 
141,015

 
3.0

 
3,229

 
2.3

 
0.5

Finance and insurance 1
 
181,628

 
3.9

 
181,628

 
100.0

 
25.3

Service, body and parts
 
478,579

 
10.2

 
235,674

 
49.2

 
32.9

Fleet and other
 
71,698

 
1.4

 
2,446

 
3.4

 
0.3

 
 
$
4,703,137

 
100.0
%
 
$
716,923

 
15.2
%
 
100.0
%
1 Commissions reported net of anticipated cancellations.

Same Store Operating Data
We believe that same store comparisons are an important indicator of our financial performance. Same store measures demonstrate our ability to grow revenues in our existing locations. As a result, same store measures have been integrated into the discussion below.
 
Same store measures reflect results for stores that were operating in each comparison period and only include the months when operations occurred in both periods. For example, a store acquired in May 2017 would be included in same store operating data beginning in June 2018, after its first full complete comparable month of operation. The second quarter operating results for the same store comparisons would include results for that store in only the period of June for both comparable periods.


New Vehicle Revenue and Gross Profit
 
 
Three Months Ended June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2018
 
2017
 
 
Reported
 
 
 
 
 
 
 
 
Revenue
 
$
1,726,803

 
$
1,384,055

 
$
342,748

 
24.8
 %
Gross profit
 
$
101,494

 
$
80,539

 
$
20,955

 
26.0

Gross margin
 
5.9
%
 
5.8
%
 
10
bp
1 
 
 
 
 
 
 
 
 
 
 
Retail units sold
 
49,027

 
40,876

 
8,151

 
19.9

Average selling price per retail unit
 
$
35,221

 
$
33,860

 
$
1,361

 
4.0

Average gross profit per retail unit
 
$
2,070

 
$
1,970

 
$
100

 
5.1

 
 
 
 
 
 
 
 


Same store
 
 

 
 

 
 

 
 

Revenue
 
$
1,380,947

 
$
1,375,444

 
$
5,503

 
0.4

Gross profit
 
$
79,141

 
$
79,830

 
$
(689
)
 
(0.9
)
Gross margin
 
5.7
%
 
5.8
%
 
(10
)bp
 


 
 
 
 
 
 
 
 


Retail units sold
 
39,619

 
40,655

 
(1,036
)
 
(2.5
)
Average selling price per retail unit
 
$
34,856

 
$
33,832

 
$
1,024

 
3.0

Average gross profit per retail unit
 
$
1,998

 
$
1,964

 
$
34

 
1.7

 
1 A basis point is equal to 1/100th of one percent

19



 
 
Six Months Ended
June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2018
 
2017
 
 
Reported
 
 
 
 
 
 
 
 
Revenue
 
$
3,181,528

 
$
2,594,359

 
$
587,169

 
22.6
 %
Gross profit
 
$
188,441

 
$
150,657

 
$
37,784

 
25.1

Gross margin
 
5.9
%
 
5.8
%
 
10
bp
1 
 

 
 
 
 
 
 
 
 
 
Retail units sold
 
90,524

 
76,492

 
14,032

 
18.3

Average selling price per retail unit
 
$
35,146

 
$
33,917

 
$
1,229

 
3.6

Average gross profit per retail unit
 
$
2,082

 
$
1,970

 
$
112

 
5.7

 
 
 
 
 
 
 
 


Same store
 
 
 
 
 
 

 
 

Revenue
 
$
2,563,814

 
$
2,576,578

 
$
(12,764
)
 
(0.5
)
Gross profit
 
$
147,226

 
$
148,887

 
$
(1,661
)
 
(1.1
)
Gross margin
 
5.7
%
 
5.8
%
 
(10
)bp
 


 
 
 
 
 
 
 
 


Retail units sold
 
73,489

 
76,031

 
(2,542
)
 
(3.3
)
Average selling price per retail unit
 
$
34,887

 
$
33,889

 
$
998

 
2.9

Average gross profit per retail unit
 
$
2,003

 
$
1,958

 
$
45

 
2.3

1 A basis point is equal to 1/100th of one percent

New vehicle sales increased 24.8% and 22.6% in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017, primarily driven by increases in volume related to acquisitions.

On a same store basis, new vehicle sales were flat in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. This was primarily due to a 2.5% decrease in unit sales, offset by a 3.0% increase in average selling price and a 3.3% decrease in unit sales, partially offset by a 2.9% increase in average selling price per unit for the three and six-month periods ended June 30, 2018, respectively, compared to the same periods of 2017. The national new vehicle sales market experienced 1.8% and 2.0% growth, respectively, during the three and six-month periods ended June 30, 2018 compared to the same periods of 2017.
 
Same store unit sales decreased as follows:

 
Three months ended June 30, 2018 compared to the same period of 2017
 
National increase (decrease) in the three months ended June 30, 2018 compared to the same period of 2017 ¹
 
Six months ended June 30, 2018 compared to the same period of 2017
 
National increase in the six months ended June 30, 2018 compared to the same period of 2017 ¹
Domestic brand same store unit sales change
 
(0.8
)%
 
3.7
 %
 
(3.3
)%
 
2.3
%
Import brand same store unit sales change
 
(3.6
)
 
(0.6
)
 
(4.0
)
 
1.0

Luxury brand same store unit sales change
 
(2.2
)
 
6.5

 
(0.3
)
 
7.2

Overall
 
(2.5
)
 
1.8

 
(3.3
)
 
2.0

1 National auto unit sales and seasonally adjusted annual rate ("SAAR") data obtained from Stephens Auto Unit Sales and SAAR report as of June 2018.

The unit volume decreases for our domestic brands exceeded the national average for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. Our performance, compared to the national trend for domestic brands, was mainly driven by General Motors and Chrysler. Our General Motors stores had same store unit sales decreases of 1.7% and 4.3%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. This performance compares to national market increases of 4.7% and 4.2% for the same periods. Our Chrysler stores had same store unit sales decreases of 0.4% and 3.0%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. This performance compares to national market increases of 8.1% and 4.7% for the same periods.

20




The unit volume decreases for our import brands exceeded the national average for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. These decreases were primarily driven by our Honda stores, which comprised 20.7% and 19.9%, respectively, of our total same store new vehicle unit sales in the three and six-month periods of 2018. Our Honda stores had same store unit decreases of 2.2% and 6.5%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017, while the national average unit volume decreases were 0.3% and 0.5%, respectively, for Honda for the same periods. Our Toyota stores, which comprised 17.9% and 18.4%, respectively, of our same store new vehicle unit sales in the three and six-month periods of 2018, had a same store unit decrease of 4.6% and was flat, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods in 2017, while the national market for Toyota decreased by 0.8% and increased 3.0%, respectively, for the same periods.

Our luxury brand unit volume decreased 2.2% and was flat in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017, which underperformed the national trend for luxury brands, and was primarily associated with our BMW stores, which comprised 3.6% of our same store new vehicle unit sales in the each of the three and six-month periods ended June 30, 2018. Our BMW stores had same store unit sales decreases of 2.3% and 4.5%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017, while the national average was an increase for BMW of 2.6% and 2.8%, respectively, for the same periods. Our Mercedes stores, accounting for 0.9% of our same store new vehicle unit sales in each of the three and six-month periods ended June 30, 2018, had a same store unit decrease of 8.8% and an increase of 6.4% for the three and six-month periods ended June 30, 2018, respectively, compared to the same periods of 2017, while the national average was a decrease for Mercedes of 2.9% and 1.9%, respectively, for the same periods. The growth in our luxury brands was less than the national average due to decreases in our local markets. We are concentrated in areas such as Seattle and New Jersey, where new vehicle registrations were down. Additionally, our BMW stores lost market share.

We seek to grow our new vehicle sales organically by gaining share in the markets we serve. To increase awareness and customer traffic, we use a combination of traditional, digital and social media advertisements to reach customers. We have established a company-wide target of achieving 25% higher sales than the national OEM average. For the six-month period ended June 30, 2018, our sales were 7% higher than the national OEM average, down from achieving 9% higher sales for the same period of 2017.

New vehicle gross profit increased 26.0% and 25.1%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. On a same store basis, new vehicle gross profit decreased 0.9% and 1.1%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. These decreases were driven by decreases in new vehicle unit sales of 2.5% an 3.3%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017, offset by increases in gross profit per unit of 1.7% and 2.3%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. The same store average gross profit per unit for new vehicles increased $34 and $45, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017.

Under our business strategy, we believe that our new vehicle sales create incremental profit opportunities through certain manufacturer incentive programs, arranging of third party financing, vehicle service and insurance contracts, future resale of used vehicles acquired through trade-in and parts and service work.



21



Used Vehicle Retail Revenue and Gross Profit
 
 
Three Months Ended June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2018
 
2017
 
 
Reported
 
 
 
 
 
 
 
 
Retail revenue
 
$
804,098

 
$
633,635

 
$
170,463

 
26.9
 %
Retail gross profit
 
$
87,101

 
$
74,506

 
$
12,595

 
16.9

Retail gross margin
 
10.8
%
 
11.8
%
 
(100
)bp
 
 

 
 
 
 
 
 
 
 
 
Retail units sold
 
39,096

 
32,171

 
6,925

 
21.5

Average selling price per retail unit
 
$
20,567

 
$
19,696

 
$
871

 
4.4

Average gross profit per retail unit
 
$
2,228

 
$
2,316

 
$
(88
)
 
(3.8
)
 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 

 
 

Retail revenue
 
$
673,955

 
$
629,198

 
$
44,757

 
7.1

Retail gross profit
 
$
76,447

 
$
74,102

 
$
2,345

 
3.2

Retail gross margin
 
11.3
%
 
11.8
%
 
(50
)bp
 
 

 
 
 
 
 
 
 
 
 
Retail units sold
 
33,328

 
31,933

 
1,395

 
4.4

Average selling price per retail unit
 
$
20,222

 
$
19,704

 
$
518

 
2.6

Average gross profit per retail unit
 
$
2,294

 
$
2,321

 
$
(27
)
 
(1.2
)
 
 
Six Months Ended
June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2018
 
2017
 
 
Reported
 
 
 
 
 
 
 
 
Retail revenue
 
$
1,519,672

 
$
1,235,858

 
$
283,814

 
23.0
 %
Retail gross profit
 
$
160,712

 
$
143,289

 
$
17,423

 
12.2

Retail gross margin
 
10.6
%
 
11.6
%
 
(100
)bp
 
 

 
 
 
 
 
 
 
 
 
Retail units sold
 
75,210

 
62,954

 
12,256

 
19.5

Average selling price per retail unit
 
$
20,206

 
$
19,631

 
$
575

 
2.9

Average gross profit per retail unit
 
$
2,137

 
$
2,276

 
$
(139
)
 
(6.1
)
 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 

 
 

Retail revenue
 
$
1,296,344

 
$
1,224,239

 
$
72,105

 
5.9

Retail gross profit
 
$
142,323

 
$
142,359

 
$
(36
)
 

Retail gross margin
 
11.0
%
 
11.6
%
 
(60
)bp
 
 

 
 
 
 
 
 
 
 
 
Retail units sold
 
65,005

 
62,337

 
2,668

 
4.3

Average selling price per retail unit
 
$
19,942

 
$
19,639

 
$
303

 
1.5

Average gross profit per retail unit
 
$
2,189

 
$
2,284

 
$
(95
)
 
(4.2
)

Used vehicle retail sales are a strategic focus for organic growth. We offer three categories of used vehicles: manufacturer certified pre-owned ("CPO") vehicles; core vehicles, or late-model vehicles with lower mileage; and value autos, or vehicles with over 80,000 miles. We have established a company-wide target of achieving a per store average of 85 used retail units per month. Strategies to achieve this target include reducing wholesale sales and selling the full spectrum of used units, from late model CPO models to vehicles over ten years old.


22



Same store sales of used vehicles increased (decreased) as follows:
 
 
Three months ended June 30, 2018 compared to the same period of 2017
 
Six months ended June 30, 2018 compared to the same period of 2017
Manufacturer CPO vehicles
 
(1.1
)%
 
(3.6
)%
Core vehicles
 
12.2

 
12.4

Value autos
 
7.2

 
2.9

Overall
 
7.1

 
5.9

 
The increases in same store used vehicle sales were primarily driven by increased unit sales in our core and value auto vehicles categories. For core vehicles, same store unit sales increased 7.1% and 9.1%, respectively, and average selling price increased 4.7% and 3.2%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. Our value auto vehicle category increased same store unit sales 4.3% and 0.7%, respectively, and average selling prices increased 2.8% and 2.1%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. The growth in our core and value auto vehicles categories was offset by decreases in our CPO vehicles. The decreases in CPO vehicle sales were driven by 0.7% and 1.5% decreases, respectively, in same store unit sales and 0.3% and 2.0% decreases, respectively, in average selling price for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017.

On an annualized average, as of June 30, 2018 , each of our stores sold 67 retail used vehicle units per month, consistent with the same period a year ago.
 
Used retail vehicle gross profit increased 16.9% and 12.2%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. On a same store basis, gross profit increased 3.2% and was flat, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017, primarily driven by increases in units sold and average selling price, partially offset by decreases in average gross profit per unit. The same store gross profit per unit decreased $27 and $95, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017.

Our used vehicle operations provide an opportunity to generate sales to customers unable or unwilling to purchase a new vehicle, sell brands other than the store’s new vehicle franchise(s) and increase sales from finance and insurance and parts and service.


Used Vehicle Wholesale Revenue and Gross Profit
 
 
Three Months Ended June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2018
 
2017
 
 
Reported
 
 
 
 
 
 
 
 
Wholesale revenue
 
$
85,335

 
$
69,512

 
$
15,823

 
22.8
 %
Wholesale gross profit
 
$
1,926

 
$
1,712

 
$
214

 
12.5

Wholesale gross margin
 
2.3
%
 
2.5
%
 
(20
)bp
 
 

 
 
 
 
 
 
 
 
 
Wholesale units sold
 
12,908

 
10,906

 
2,002

 
18.4

Average selling price per wholesale unit
 
$
6,611

 
$
6,374

 
$
237

 
3.7

Average gross profit per retail unit
 
$
149

 
$
157

 
$
(8
)
 
(5.1
)

23



 
 
Six Months Ended
June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands, except per unit amounts)
 
2018
 
2017
 
 
Reported
 
 
 
 
 
 
 
 
Wholesale revenue
 
$
161,290

 
$
141,015

 
$
20,275

 
14.4
 %
Wholesale gross profit
 
$
2,852

 
$
3,229

 
$
(377
)
 
(11.7
)
Wholesale gross margin
 
1.8
%
 
2.3
%
 
(50
)bp
 
 

 
 
 
 
 
 
 
 
 
Wholesale units sold
 
24,595

 
21,746

 
2,849

 
13.1

Average selling price per wholesale unit
 
$
6,558


$
6,485

 
$
73

 
1.1

Average gross profit per retail unit
 
$
116

 
$
148

 
$
(32
)
 
(21.6
)

Wholesale transactions are vehicles we have purchased from customers or vehicles we have attempted to sell via retail that we elect to dispose of due to age or other factors. Wholesale vehicles are typically sold at or near cost and do not comprise a meaningful component of our gross profit.


Finance and Insurance
 
 
Three Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands, except per unit amounts)
 
2018
 
2017
 
 
Reported
 
 
 
 
 
 
 
 
Revenue
 
$
114,492

 
$
94,851

 
$
19,641

 
20.7
%
Average finance and insurance per retail unit
 
$
1,299

 
$
1,298

 
$
1

 
0.1
%
 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 
 
 
Revenue
 
$
95,177

 
$
94,244

 
$
933

 
1.0
%
Average finance and insurance per retail unit
 
$
1,305

 
$
1,298

 
$
7

 
0.5
%
 
 
Six Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands, except per unit amounts)
 
2018
 
2017
 
 
Reported
 
 
 
 
 
 
 
 
Revenue
 
$
220,997

 
$
181,628

 
$
39,369

 
21.7
%
Average finance and insurance per retail unit
 
1,333

 
1,302

 
31

 
2.4

 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 
 
 
Revenue
 
$
185,668

 
$
180,322

 
$
5,346

 
3.0
%
Average finance and insurance per retail unit
 
1,341

 
1,303

 
38

 
2.9


We believe that arranging timely vehicle financing is an important part of our ability to sell vehicles and we attempt to arrange financing for every vehicle we sell. We also offer related products such as extended warranties, insurance contracts and vehicle and theft protection.

The increases in finance and insurance revenue in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017 were primarily due to increased volume related to acquisitions, combined with expanded product offerings. Third-party extended warranty and insurance contracts yield higher profit margins than vehicle sales and contribute significantly to our profitability. Same store finance and insurance revenues increased 1.0% and 3.0%, respectively, for the three and six-month periods ended June 30, 2018 as compared to the same periods of 2017. These increases were driven by increases in finance and insurance revenues per retail unit, combined with increases in used vehicle unit volume, offset by decreases in new vehicle unit volume. On a same store basis, our finance and insurance revenues per retail unit increased $7 and $38, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017, primarily due to increased penetration rates related to finance and insurance contracts.


24



Trends in penetration rates for total new and used retail vehicles sold are detailed below:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Finance and insurance
 
73
%
 
71
%
 
72
%
 
71
%
Service contracts
 
45

 
44

 
46

 
45

Lifetime lube, oil and filter contracts
 
24

 
25

 
25

 
25


We seek to increase our penetration of vehicle financing on the number of vehicles that we sell and to offer a comprehensive suite of products. We target an average F&I per retail unit of $1,450. We believe improved performance from sales training and revised compensation plans will be critical factors in achieving this target.


Service, Body and Parts Revenue and Gross Profit
 
 
Three Months Ended June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
 
Reported
 
 
 
 
 
 
 
 
Customer pay
 
$
172,333

 
$
135,851

 
$
36,482

 
26.9
 %
Warranty
 
72,561

 
56,703

 
15,858

 
28.0

Wholesale parts
 
45,310

 
35,631

 
9,679

 
27.2

Body shop
 
21,203

 
17,820

 
3,383

 
19.0

Total service, body and parts
 
$
311,407

 
$
246,005

 
$
65,402

 
26.6
 %
 
 
 
 
 
 
 
 
 
Service, body and parts gross profit
 
$
153,707

 
$
122,480

 
$
31,227

 
25.5
 %
Service, body and parts gross margin
 
49.4
%
 
49.8
%
 
(40) bp

 
 
 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 
 
 
Customer pay
 
$
141,173

 
$
134,406

 
$
6,767

 
5.0
 %
Warranty
 
56,897

 
56,296

 
601

 
1.1

Wholesale parts
 
36,082

 
35,255

 
827

 
2.3

Body shop
 
17,297

 
17,646

 
(349
)
 
(2.0
)
Total service, body and parts
 
$
251,449

 
$
243,603

 
$
7,846

 
3.2
 %
 
 
 
 
 
 
 
 
 
Service, body and parts gross profit
 
$
124,751

 
$
121,368

 
$
3,383

 
2.8
 %
Service, body and parts gross margin
 
49.6
%
 
49.8
%
 
(20) bp

 
 


25



 
 
Six Months Ended
June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
 
Reported
 
 
 
 
 
 
 
 
Customer pay
 
$
322,181

 
$
258,471

 
$
63,710

 
24.6
 %
Warranty
 
140,869

 
111,202

 
29,667

 
26.7

Wholesale parts
 
90,919

 
72,333

 
18,586

 
25.7

Body shop
 
43,135

 
36,573

 
6,562

 
17.9

Total service, body and parts
 
$
597,104

 
$
478,579

 
$
118,525

 
24.8
 %
 
 
 
 
 
 
 
 
 
Service, body and parts gross profit
 
$
292,115

 
$
235,674

 
$
56,441

 
23.9
 %
Service, body and parts gross margin
 
48.9
%
 
49.2
%
 
(30
) bp
 
 

 
 
 
 
 
 
 
 
 
Same store
 
 
 
 
 
 
 
 
Customer pay
 
$
266,433

 
$
255,452

 
$
10,981

 
4.3
 %
Warranty
 
112,518

 
110,233

 
2,285

 
2.1

Wholesale parts
 
72,680

 
71,430

 
1,250

 
1.7

Body shop
 
35,629

 
35,872

 
(243
)
 
(0.7
)
Total service, body and parts
 
$
487,260

 
$
472,987

 
$
14,273

 
3.0
 %
 
 
 
 
 
 
 
 
 
Service, body and parts gross profit
 
$
240,773

 
$
233,025

 
$
7,748

 
3.3
 %
Service, body and parts gross margin
 
49.4
%
 
49.3
%
 
10
 bp
 
 


We provide service, body and parts for the new vehicle brands sold by our stores, as well as service and repairs for most other makes and models. Our parts and service operations are an integral part of our customer retention and the largest contributor to our overall profitability. Earnings from service, body and parts have historically been more resilient during economic downturns, when owners have tended to repair their existing vehicles rather than buy new vehicles.

Our service, body, and parts revenue grew in all areas in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. The growth experienced in the three and six-month periods ended June 30, 2018 was primarily due to acquisitions, combined with more late-model units in operation from 2010 to 2016 and a plateauing new vehicle market. We believe the increased number of units in operation will continue to benefit our service, body and parts revenue in the coming years as more late-model vehicles age, necessitating repairs and maintenance.
 
We focus on retaining customers by offering competitively-priced routine maintenance and through our marketing efforts. We increased our same store customer pay revenue 5.0% and 4.3%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017.
 
Same store warranty revenue increased 1.1% and 2.1%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. Warranty sales growth was primarily driven by increases in domestic segment recalls, particularly Chrysler, which had increases of 17.9% and 16.1%, respectively, and Ford, which had increases of 4.3% and 8.7%, respectively. These increases were offset by decreases in Honda of 26.5% and 25.1%, respectively, and decreases of 11.6% and 19.4%, respectively, in Nissan warranty work in the three and six-month periods ended June 30, 2018 as compared to the same periods of 2017.
 
The increase (decrease) in same-store warranty work by segment was as follows:
 
 
Three months ended June 30, 2018 compared to the same period of 2017
 
Six months ended June 30, 2018 compared to the same period of 2017
Domestic
 
11.2
 %
 
11.5
 %
Import
 
(5.5
)
 
(4.6
)
Luxury
 
(1.8
)
 
0.5

 

26



Same store wholesale parts revenue increased 2.3% and 1.7%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. We target independent repair shops, competing new vehicle dealers and wholesale accounts to expand parts sales to other repair shops.
 
Same store body shop revenue decreased 2.0% and 0.7%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. These decreases were primarily due to milder winter weather in areas in which our body shops are located.

Same store service, body and parts gross profit increased 2.8% and 3.3%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. Our gross margins have increased as our mix shifts towards customer pay, which has higher margins than other service work.


Segments
Certain financial information by segment is as follows:
 
 
Three Months Ended June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Revenues:
 
 
 
 
 
 
 
 
Domestic
 
$
1,095,068

 
$
954,949

 
$
140,119

 
14.7
%
Import
 
1,322,730

 
1,095,239

 
227,491

 
20.8

Luxury
 
677,530

 
419,163

 
258,367

 
61.6

 
 
3,095,328

 
2,469,351

 
625,977

 
25.3

Corporate and other
 
1,209

 
(2,315
)
 
3,524

 
NM

 
 
$
3,096,537

 
$
2,467,036

 
$
629,501

 
25.5
%
NM - not meaningful
 
 
Six Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Revenues:
 
 
 
 
 
 
 
 
Domestic
 
$
2,065,685

 
$
1,854,707

 
$
210,978

 
11.4
%
Import
 
2,493,163

 
2,066,711

 
426,452

 
20.6

Luxury
 
1,194,025

 
782,967

 
411,058

 
52.5

 
 
5,752,873

 
4,704,385

 
1,048,488

 
22.3

Corporate and other
 
3,343

 
(1,248
)
 
4,591

 
NM

 
 
$
5,756,216

 
$
4,703,137

 
$
1,053,079

 
22.4
%
NM - not meaningful
 
 
Three Months Ended June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
 
Segment income1:
 
 
 
 
 
 
 
 
Domestic
 
$
28,545

 
$
27,857

 
$
688

 
2.5
 %
Import
 
30,244

 
32,238

 
(1,994
)
 
(6.2
)
Luxury
 
11,939

 
10,315

 
1,624

 
15.7

 
 
70,728

 
70,410

 
318

 
0.5

Corporate and other
 
41,015

 
38,239

 
2,776

 
7.3

Depreciation and amortization
 
(18,821
)
 
(14,031
)
 
4,790

 
34.1

Other interest expense
 
(13,829
)
 
(7,169
)
 
6,660

 
92.9

Other income, net
 
1,659

 
387

 
1,272

 
NM

Income before income taxes
 
$
80,752

 
$
87,836

 
$
(7,084
)
 
(8.1
)%
 
NM – not meaningful

27



 
 
Six Months Ended
June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
 
Segment income1:
 
 
 
 
 
 
 
 
Domestic
 
$
54,163

 
$
53,299

 
$
864

 
1.6
 %
Import
 
53,265

 
54,411

 
(1,146
)
 
(2.1
)
Luxury
 
18,826

 
15,027

 
3,799

 
25.3

 
 
126,254

 
122,737

 
3,517

 
2.9

Corporate and other
 
82,572

 
76,740

 
5,832

 
7.6

Depreciation and amortization
 
(35,675
)
 
(26,770
)
 
8,905

 
33.3

Other interest expense
 
(25,635
)
 
(13,840
)
 
11,795

 
85.2

Other income, net
 
3,033

 
10,232

 
(7,199
)
 
NM

Income before income taxes
 
$
150,549

 
$
169,099

 
$
(18,550
)
 
(11.0
)%
1Segment income for each reportable segment is defined as income before income taxes, depreciation and amortization, other interest expense and other expense, net.

NM – Not meaningful
 
 
Three Months Ended June 30,
 
Increase
 
% Increase
 
 
2018
 
2017
 
 
Retail new vehicle unit sales:
 
 
 
 
 
 
 
 
Domestic
 
14,697

 
13,256

 
1,441

 
10.9
%
Import
 
27,376

 
23,187

 
4,189

 
18.1

Luxury
 
7,050

 
4,523

 
2,527

 
55.9

 
 
49,123

 
40,966

 
8,157

 
19.9

Allocated to management
 
(96
)
 
(90
)
 
6

 
NM

 
 
49,027

 
40,876

 
8,151

 
19.9
%
NM – Not meaningful
 
 
Six Months Ended
June 30,
 
Increase
 
% Increase
 
 
2018
 
2017
 
 
Retail new vehicle unit sales:
 
 
 
 
 
 
 
 
Domestic
 
27,353

 
25,496

 
1,857

 
7.3
%
Import
 
51,016

 
43,022

 
7,994

 
18.6

Luxury
 
12,388

 
8,139

 
4,249

 
52.2

 
 
90,757

 
76,657

 
14,100

 
18.4

Allocated to management
 
(233
)
 
(165
)
 
68

 
NM

 
 
90,524

 
76,492

 
14,032

 
18.3
%
NM – Not meaningful



28



Domestic
A summary of financial information for our Domestic segment follows:
 
 
Three Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
New vehicle
 
$
597,596

 
$
528,649

 
$
68,947

 
13.0
%
Used vehicle retail
 
283,408

 
251,214

 
32,194

 
12.8

Used vehicle wholesale
 
33,913

 
30,700

 
3,213

 
10.5

Finance and insurance
 
43,083

 
37,354

 
5,729

 
15.3

Service, body and parts
 
113,472

 
96,515

 
16,957

 
17.6

Fleet and other
 
23,596

 
10,517

 
13,079

 
124.4

Revenue
 
$
1,095,068

 
$
954,949

 
$
140,119

 
14.7

Segment income
 
$
28,545

 
$
27,857

 
$
688

 
2.5

Retail new vehicle unit sales
 
14,697

 
13,256

 
1,441

 
10.9

 
 
Six Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Revenue:
 
 
 
 
 
 
 
 
New vehicle
 
$
1,111,125

 
$
1,013,906

 
$
97,219

 
9.6
%
Used vehicle retail
 
548,235

 
496,212

 
52,023

 
10.5

Used vehicle wholesale
 
67,519

 
62,986

 
4,533

 
7.2

Finance and insurance
 
83,083

 
73,562

 
9,521

 
12.9

Service, body and parts
 
220,614

 
189,917

 
30,697

 
16.2

Fleet and other
 
35,109

 
18,124

 
16,985

 
93.7

 
 
$
2,065,685

 
$
1,854,707

 
$
210,978

 
11.4
%
Segment income
 
$
54,163

 
$
53,299

 
$
864

 
1.6
%
Retail new vehicle unit sales
 
27,353

 
25,496

 
1,857

 
7.3
%

Our Domestic segment revenue increased 14.7% and 11.4%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. Since June 2017, we acquired seven additional domestic brand stores, which contributed to increases in all major business lines.

Our Domestic segment income increased 2.5% and 1.6%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017, primarily due to gross profits growth of 14.1% and 11.2%, respectively, which was in line with revenue growth, offset by growth in SG&A of 14.4% and 10.8%, respectively, and increases in floor plan interest expense of 47.6% and 46.8%, respectively, due to acquisitions and rising interest rates compared to the same periods of 2017. These factors resulted in slower domestic segment income growth than revenue growth for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017.



29



Import
A summary of financial information for our Import segment follows:
 
 
Three Months Ended
June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
 
New vehicle
 
$
771,987

 
$
643,404

 
$
128,583

 
20.0
 %
Used vehicle retail
 
335,629

 
269,512

 
66,117

 
24.5

Used vehicle wholesale
 
30,983

 
27,283

 
3,700

 
13.6

Finance and insurance
 
54,866

 
45,282

 
9,584

 
21.2

Service, body and parts
 
116,386

 
96,964

 
19,422

 
20.0

Fleet and other
 
12,879

 
12,794

 
85

 
0.7

Revenue
 
$
1,322,730

 
$
1,095,239

 
$
227,491

 
20.8

Segment income
 
$
30,244

 
$
32,238

 
$
(1,994
)
 
(6.2
)
Retail new vehicle unit sales
 
27,376

 
23,187

 
4,189

 
18.1

 
 
Six Months Ended
June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
 
Revenue:
 
 
 
 
 
 
 
 
New vehicle
 
$
1,439,590

 
$
1,195,286

 
$
244,304

 
20.4
 %
Used vehicle retail
 
643,317

 
516,788

 
126,529

 
24.5

Used vehicle wholesale
 
59,178

 
54,120

 
5,058

 
9.3

Finance and insurance
 
106,562

 
85,855

 
20,707

 
24.1

Service, body and parts
 
226,041

 
185,626

 
40,415

 
21.8

Fleet and other
 
18,475

 
29,036

 
(10,561
)
 
(36.4
)
 
 
$
2,493,163

 
$
2,066,711

 
$
426,452

 
20.6
 %
Segment income
 
$
53,265

 
$
54,411

 
$
(1,146
)
 
(2.1
)%
Retail new vehicle unit sales
 
51,016

 
43,022

 
7,994

 
18.6
 %
 
Our Import segment revenue increased 20.8% and 20.6%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017 due to increases in all major business lines, primarily as a result of the acquisition of eleven import brand stores since June 2017, as well as same store increases in used vehicle unit volume and a small increase in finance and insurance per unit.

Import segment income decreased 6.2% and 2.1%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. The decreases were primarily due to SG&A expense growth of 22.8% and 23.0%, respectively, partially offset by gross profit growth of 18.9% and 20.3%, respectively. Total import SG&A as a percent of gross profit increased from 76.5% to 79.0% and from 78.7% to 80.4%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. Recently acquired stores were the main contributor to the increases as newly acquired stores generally have a lower operating efficiency than our other stores. Floor plan interest expense for import stores increased 65.7% and 63.3%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017 and was a significant contributor to the slower growth in segment income.



30



Luxury
A summary of financial information for our Luxury segment follows:
 
 
Three Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
New vehicle
 
$
361,913

 
$
220,388

 
$
141,525

 
64.2
%
Used vehicle retail
 
184,941

 
112,032

 
72,909

 
65.1

Used vehicle wholesale
 
20,263

 
11,473

 
8,790

 
76.6

Finance and insurance
 
15,934

 
9,525

 
6,409

 
67.3

Service, body and parts
 
76,883

 
50,326

 
26,557

 
52.8

Fleet and other
 
17,596

 
15,419

 
2,177

 
14.1

Revenue
 
$
677,530

 
$
419,163

 
$
258,367

 
61.6

Segment income
 
$
11,939

 
$
10,315

 
$
1,624

 
15.7

Retail new vehicle unit sales
 
7,050

 
4,523

 
2,527

 
55.9

 
 
Six Months Ended
June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
 
Revenue:
 
 
 
 
 
 
 
 
New vehicle
 
$
640,434

 
$
396,705

 
$
243,729

 
61.4
 %
Used vehicle retail
 
327,845

 
222,637

 
105,208

 
47.3

Used vehicle wholesale
 
34,463

 
23,696

 
10,767

 
45.4

Finance and insurance
 
28,185

 
17,519

 
10,666

 
60.9

Service, body and parts
 
141,676

 
98,358

 
43,318

 
44.0

Fleet and other
 
21,422

 
24,052

 
(2,630
)
 
(10.9
)
 
 
$
1,194,025

 
$
782,967

 
$
411,058

 
52.5
 %
Segment income
 
$
18,826

 
$
15,027

 
$
3,799

 
25.3
 %
Retail new vehicle unit sales
 
12,388

 
8,139

 
4,249

 
52.2
 %
Our Luxury segment revenue increased 61.6% and 52.5%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017 due to increases in all major business lines. Since June 2017, we added nine luxury brand stores.
 
Our Luxury segment income increased 15.7% and 25.3%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017, primarily due to gross profit growth of 57.2% and 48.4%, respectively, offset by SG&A expense increases of 64.0% and 50.1%, respectively. Total Luxury segment SG&A as a percent of gross profit increased from 77.6% to 81.0% and from 81.5% to 82.4%, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017, primarily related to increases in personnel and rent related to recently acquired stores. Growth in our Luxury segment revenues and gross profit for the three and six-month periods ended June 30, 2018 was driven by volume related to acquisitions and an increase in finance and insurance per unit. Floor plan interest expense increased 86.6% and 77.3%, respectively, related to a combination of increased volume from acquisitions and rising interest rates.


Corporate and Other
Revenues attributable to Corporate and other include the results of operations of our stand-alone body shop, offset by certain unallocated reserve and elimination adjustments related to vehicle sales.
 
 
Three Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Revenue, net
 
$
1,209

 
$
(2,315
)
 
$
3,524

 
NM
Segment income
 
$
41,015

 
$
38,239

 
$
2,776

 
7.3

31



 
 
Six Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Revenue, net
 
$
3,343

 
$
(1,248
)
 
$
4,591

 
NM
Segment income
 
$
82,572

 
$
76,740

 
$
5,832

 
7.6
NM - not meaningful
 
The increases in Corporate and other revenue in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017 were primarily related to the addition of two stand-alone body shops, changes to certain reserves that are not specifically identified with our domestic, import or luxury segment revenue, such as our reserve for revenue reversals associated with unwound vehicle sales, and elimination of revenues associated with internal corporate vehicle purchases and leases with our stores.
 
Segment income attributable to Corporate and other includes amounts associated with the operating income from our stand-alone body shops, and certain internal corporate expense allocations that reduce reportable segment income but increase Corporate and other income. These internal corporate expense allocations are used to increase comparability of our dealerships and reflect the capital burden a stand-alone dealership would experience. Examples of these internal allocations include internal rent expense, internal floor plan financing charges, and internal fees charged to offset employees within our corporate headquarters who perform certain dealership functions.

Corporate and other segment income increased $2.8 million and $5.8 million, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017, primarily due to the addition of 27 stores and two stand-alone body shops since June 30, 2017.


Selling, General and Administrative Expense (“SG&A”)
SG&A includes salaries and related personnel expenses, advertising (net of manufacturer cooperative advertising credits), rent, facility costs, and other general corporate expenses.
 
 
Three Months Ended June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Personnel
 
$
213,667

 
$
167,324

 
$
46,343

 
27.7
%
Advertising
 
27,609

 
22,988

 
4,621

 
20.1

Rent
 
11,946

 
7,227

 
4,719

 
65.3

Facility costs
 
18,552

 
14,252

 
4,300

 
30.2

Other
 
61,576

 
45,499

 
16,077

 
35.3

Total SG&A
 
$
333,350

 
$
257,290

 
$
76,060

 
29.6
%
 
 
Three Months Ended June 30,
 
Increase (Decrease)
As a % of gross profit
 
2018
 
2017
 
Personnel
 
46.4
%
 
44.6
%
 
180
bp
Advertising
 
6.0

 
6.1

 
(10
)
Rent
 
2.6

 
1.9

 
70

Facility costs
 
4.0

 
3.8

 
20

Other
 
13.4

 
12.2

 
120

Total SG&A
 
72.4
%
 
68.6
%
 
380
bp

32



 
 
Six Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Personnel
 
$
405,760

 
$
330,996

 
$
74,764

 
22.6
%
Advertising
 
53,090

 
42,944

 
10,146

 
23.6

Rent
 
23,063

 
14,448

 
8,615

 
59.6

Facility costs
 
36,220

 
29,379

 
6,841

 
23.3

Other
 
112,711

 
82,295

 
30,416

 
37.0

Total SG&A
 
$
630,844

 
$
500,062

 
$
130,782

 
26.2
%
 
 
Six Months Ended
June 30,
 
Increase
As a % of gross profit
 
2018
 
2017
 
Personnel
 
46.7
%
 
46.2
%
 
50
bp
Advertising
 
6.1
%
 
6.0
%
 
10

Rent
 
2.7
%
 
2.0
%
 
70

Facility costs
 
4.2
%
 
4.1
%
 
10

Other
 
12.9
%
 
11.5
%
 
140

Total SG&A
 
72.6
%
 
69.8
%
 
280
bp
 

SG&A expense increased 29.6% and 26.2%, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. Overall, increases in SG&A expense were due primarily to growth through acquisitions, acquisition expenses, losses related to storm insurance reserve charges and increased allowance losses associated with auto loan receivables. Other expenses in the three and six-month periods ended June 30, 2018 include acquisition expenses of $3.3 million and $4.2 million, respectively, and storm insurance reserve charges of $1.5 million and $3.2 million, respectively. Auto loan receivable allowance losses increased $3.8 million and $5.8 million, respectively, for the three and six-month periods ended June 30, 2018 compared to the same periods of 2017.

On a same store basis and excluding non-core charges, SG&A as a percentage of gross profit was 70.8% and 71.5%, respectively, for the three and six-month periods ended June 30, 2018 compared to 66.8% and 68.8%, respectively, for the same periods of 2017. These increases were primarily due to increased personnel cost and auto loan receivable allowance losses recorded in the three and six-month periods ended June 30, 2018.

SG&A expense adjusted for non-core charges was as follows (in thousands):
 
 
Three Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Personnel
 
$
213,667

 
$
167,324

 
$
46,343

 
27.7
%
Advertising
 
27,609

 
22,988

 
4,621

 
20.1

Rent
 
11,946

 
7,227

 
4,719

 
65.3

Facility costs
 
18,552

 
14,252

 
4,300

 
30.2

Adjusted other
 
56,835

 
39,484

 
17,351

 
43.9

Adjusted total SG&A
 
$
328,609

 
$
251,275

 
$
77,334

 
30.8
%

33



 
 
Three Months Ended
June 30,
 
Increase (Decrease)
As a % of gross profit
 
2018
 
2017
 
Personnel
 
46.4
%
 
44.6
%
 
180
bp
Advertising
 
6.0
%
 
6.1
%
 
(10
)
Rent
 
2.6
%
 
1.9
%
 
70

Facility costs
 
4.0
%
 
3.8
%
 
20

Adjusted other
 
12.3
%
 
10.6
%
 
170

Adjusted total SG&A
 
71.3
%
 
67.0
%
 
430
bp
 
 
Six Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Personnel
 
$
405,760

 
$
330,996

 
$
74,764

 
22.6
%
Advertising
 
53,090

 
42,944

 
10,146

 
23.6
%
Rent
 
23,063

 
14,448

 
8,615

 
59.6
%
Facility costs
 
36,220

 
29,379

 
6,841

 
23.3
%
Adjusted other
 
107,970

 
76,280

 
31,690

 
41.5
%
Adjusted total SG&A
 
$
626,103

 
$
494,047

 
$
132,056

 
26.7
%
 
 
Six Months Ended
June 30,
 
Increase
As a % of gross profit
 
2018
 
2017
 
Personnel
 
46.7
%
 
46.2
%
 
50
bp
Advertising
 
6.1
%
 
6.0
%
 
10

Rent
 
2.7
%
 
2.0
%
 
70

Facility costs
 
4.2
%
 
4.1
%
 
10

Adjusted other
 
12.4
%
 
10.6
%
 
180

Adjusted total SG&A
 
72.1
%
 
68.9
%
 
320
bp

Adjusted SG&A for the three and six-month periods ended June 30, 2018 excludes acquisition related expenses of $3.3 million and storm insurance reserve related charges of $1.5 million. Adjusted SG&A excludes acquisition related expenses of $2.1 million in the three and six-month periods ended June 30, 2017 and storm insurance reserve related charges of $3.9 million. See “Non-GAAP Reconciliations” for more details.


Depreciation and Amortization
Depreciation and amortization is comprised of depreciation expense related to buildings, significant remodels or improvements, furniture, tools, equipment and signage and amortization of certain intangible assets, including customer lists and non-compete agreements.
 
 
Three Months Ended June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Depreciation and amortization
 
$
18,821

 
$
14,031

 
$
4,790

 
34.1
%
 
 
Six Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Depreciation and amortization
 
$
35,675

 
$
26,770

 
$
8,905

 
33.3
%

The increases in depreciation and amortization in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017 were primarily due to capital expenditures and acquisitions that occurred since June 30, 2017. Since June 30, 2017, we purchased approximately $258 million in depreciable buildings and improvements as a part of our acquisitions of

34



Downtown LA Auto Group, Day Automotive Group, and Prestige Auto Group. Capital expenditures for the first six months of 2018 totaled $72.4 million, which also increases the amount of depreciable assets. See the discussion under Liquidity and Capital Resources for additional information.

Operating Margin
Operating income as a percentage of revenue, or operating margin, was as follows:
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
2018
 
2017
Operating margin
 
3.5
%
 
4.2
%
 
3.5
%
 
4.0
%
Operating margin adjusted for non-core charges 1
 
3.7
%
 
4.5
%
 
3.6
%
 
4.2
%
1 See “Non-GAAP Reconciliations” for more details.
 
Operating margin declined 70 and 50 basis points, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods in 2017. Acquisition activity over the past twelve months negatively impacted our operating margin. Acquired stores generally have a lower operating efficiency than our other stores and negatively impact our operating margin until we fully integrate them into our cost structure.

Floor Plan Interest Expense and Floor Plan Assistance
 
 
Three Months Ended
June 30,
 
 
 
Six Months Ended
June 30,
 
 
(Dollars in thousands)
 
2018
 
2017
 
% Change
 
2018
 
2017
 
% Change
Floor plan interest expense (new vehicles)
 
$
15,634

 
$
9,332

 
67.5
%
 
$
29,168

 
$
17,384

 
67.8
%

Floor plan interest expense increased $6.3 million and $11.8 million, respectively, in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017. The 67.5% increase in floor plan interest expense for the three-month period ended June 30, 2018 compared to the same period in 2017 includes a 2.9% increase related to the increase in same store inventory levels, a 31.1% increase due to acquisition volume, and a 33.5% increase related to increasing LIBOR rates as compared to the same period of 2017. The 67.8% increase in floor plan interest expense for the six-month period ended June 30, 2018 compared to the same period in 2017 includes a 2.9% increase related to the increase in same store inventory levels, a 28.4% increase due to acquisition volume, and a 36.5% increase related to increasing LIBOR rates compared to the same period of 2017.
 
Floor plan assistance is provided by manufacturers to support store financing of new vehicle inventory. Under accounting standards, floor plan assistance is recorded as a component of new vehicle gross profit when the specific vehicle is sold. However, because manufacturers provide this assistance to offset inventory carrying costs, we believe a comparison of floor plan interest expense to floor plan assistance is a useful measure of the efficiency of our new vehicle sales relative to stocking levels.

The following tables detail the carrying costs for new vehicles and include new vehicle floor plan interest net of floor plan assistance earned.

 
 
Three Months Ended June 30,
 
 
 
%
(Dollars in thousands)
 
2018
 
2017
 
Change
 
Change
Floor plan interest expense (new vehicles)
 
$
15,634

 
$
9,332

 
$
6,302

 
67.5
 %
Floor plan assistance (included as an offset to cost of sales)
 
(17,482
)
 
(13,268
)
 
(4,214
)
 
31.8

Net new vehicle carrying costs
 
$
(1,848
)
 
$
(3,936
)
 
$
2,088

 
(53.0
)%


35



 
 
Six Months Ended
June 30,
 
 
 
%
(Dollars in thousands)
 
2018
 
2017
 
Change
 
Change
Floor plan interest expense (new vehicles)
 
$
29,168

 
$
17,384

 
$
11,784

 
67.8
 %
Floor plan assistance (included as an offset to cost of sales)
 
(31,650
)
 
(25,056
)
 
(6,594
)
 
26.3

Net new vehicle carrying costs
 
$
(2,482
)
 
$
(7,672
)
 
$
5,190

 
(67.6
)%


Other Interest Expense
Other interest expense includes interest on debt incurred related to acquisitions, real estate mortgages, our used vehicle inventory financing facility and our revolving line of credit.
 
 
Three Months Ended June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Mortgage interest
 
$
5,754

 
$
4,694

 
$
1,060

 
22.6

Other interest
 
8,357

 
2,585

 
5,772

 
223.3

Capitalized interest
 
(282
)
 
(110
)
 
172

 
156.4

Total other interest expense
 
$
13,829

 
$
7,169

 
6,660

 
92.9
%
 
 
Six Months Ended
June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Mortgage interest
 
$
10,661

 
$
9,085

 
$
1,576

 
17.3
%
Other interest
 
15,459

 
4,948

 
10,511

 
212.4

Capitalized interest
 
(485
)
 
(193
)
 
292

 
151.3

Total other interest expense
 
$
25,635

 
$
13,840

 
11,795

 
85.2
%

The increases of $6.7 million and $11.8 million, respectively, in other interest expense in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017 were primarily due to $300 million in 5.25% Senior Notes issued in July 2017, which contributed $4.1 million and $8.1 million, respectively, of additional interest expense compared to the same periods of 2017. Additionally, higher volumes of borrowing on our credit facility and higher mortgage interest due to additional mortgage financings and increased interest rates contributed to the overall increases in other interest expense in the three and six-month periods ended June 30, 2018 compared to the same periods of 2017.


Other Income, Net
 
 
Three Months Ended June 30,
 
Increase
 
% Increase
(Dollars in thousands)
 
2018
 
2017
 
 
Other Income, net
 
$
1,659

 
$
387

 
$
1,272

 
NM
 
 
Six Months Ended
June 30,
 
Decrease
 
% Decrease
(Dollars in thousands)
 
2018
 
2017
 
 
Other Income, net
 
$
3,033

 
$
10,232

 
$
(7,199
)
 
NM

Other income, net in the six-month period ended June 30, 2017 was primarily related to a 9.1 million legal settlement with two OEMs associated with diesel emissions litigation.


36



Income Tax Provision
Our effective income tax rate was as follows:
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
2018
 
2017
Effective income tax rate
 
24.9
%
 
39.4
%
 
25.1
%
 
38.5
%
 
Our effective income tax rate for the three and six-month periods ended June 30, 2018 was positively affected by the enactment of tax legislation commonly known as the Tax Cuts and Jobs Act (the "Act"), signed into law on December 22, 2017, which reduced the Federal corporate income tax rate to 21.0%. Our effective income tax rate in the second quarter of 2018 benefited from the revaluation of certain acquired deferred tax liabilities. Additionally, our effective income tax rate in the six-month period ended June 30, 2018 was favorably affected by excess tax benefits related to stock-based compensation, resulting in a lower effective rate than expected for the full year. Partially offsetting these benefits was the negative impact from an increasing presence in states with higher income tax rates. We estimate our annual effective tax rate, excluding non-core charges, to be 26%.

We are still analyzing certain aspects of the Act. In particular, we have not been able to make a reasonable estimate of the potential impact of the effect of the new limitations on executive compensation under Internal Revenue Code Section 162(m). We continue to account for the deferred tax asset associated with this item under the provisions of the tax laws that were in effect immediately prior to enactment. As noted at December 31, 2017, we were able to reasonably estimate effects and, therefore, recorded provisional adjustments associated with certain items. We have not made any additional measurement-period adjustments related to these items. However, we continue to make and refine our calculations as additional analysis is completed, further guidance is issued, or new information is made available and adjustments may be made in future periods. We will complete our accounting for the Tax Act in 2018.

Non-GAAP Reconciliations
We believe each of the non-GAAP financial measures below improves the transparency of our disclosures, provides a meaningful presentation of our results from the core business operations because they exclude adjustments for items not related to our ongoing core business operations and other non-cash adjustments, and improves the period-to-period comparability of our results from the core business operations. We use these measures in conjunction with GAAP financial measures to assess our business, including our compliance with covenants in our credit facility and in communications with our Board of Directors concerning financial performance. These measures should not be considered an alternative to GAAP measures.

The following tables reconcile certain reported non-GAAP measures to the most comparable GAAP measure from our Consolidated Statements of Operations.

 
 
Three Months Ended June 30, 2018
(Dollars in thousands, except per share amounts)
 
As reported
 
Insurance reserves
 
Acquisition expenses
 
Tax attribute
 
Adjusted
Selling, general and administrative
 
$
333,350

 
$
(1,490
)
 
$
(3,251
)
 
$

 
$
328,609

Operating income
 
108,556

 
1,490

 
3,251

 

 
113,297

 
 
 
 
 
 
 
 
 
 
 
Income before income taxes
 
$
80,752

 
$
1,490

 
$
3,251

 
$

 
$
85,493

Income tax provision
 
(20,092
)
 
(389
)
 
(853
)
 
(1,409
)
 
(22,743
)
Net income (loss)
 
$
60,660

 
$
1,101

 
$
2,398

 
$
(1,409
)
 
$
62,750

 
 
 
 
 
 
 
 
 
 
 
Diluted net income (loss) per share
 
$
2.44

 
$
0.04

 
$
0.10

 
$
(0.06
)
 
$
2.52

Diluted share count
 
24,882

 
 
 
 
 
 
 
 

37



 
 
Three Months Ended June 30, 2017
(Dollars in thousands, except per share amounts)
 
As reported
 
Insurance reserves
 
Acquisition expense
 
Adjusted
Selling, general and administrative
 
$
257,290

 
$
(3,878
)
 
$
(2,137
)
 
$
251,275

Operating income
 
103,950

 
3,878

 
2,137

 
109,965

 
 
 
 
 
 
 
 
 
Income before income taxes
 
$
87,836

 
$
3,878

 
$
2,137

 
$
93,851

Income tax provision
 
(34,636
)
 
(1,231
)
 
(821
)
 
(36,688
)
Net income
 
$
53,200

 
$
2,647

 
$
1,316

 
$
57,163

 
 
 
 
 
 
 
 
 
Diluted net income per share
 
$
2.12

 
$
0.11

 
0.05

 
$
2.28

Diluted share count
 
25,106

 
 
 
 
 
 
 
 
Six Months Ended June 30, 2018
(Dollars in thousands, except per share amounts)
 
As reported
 
Insurance reserves
 
Acquisition expenses
 
Tax attribute
 
Adjusted
Selling, general and administrative
 
$
630,844

 
$
(1,490
)
 
$
(3,251
)
 
$

 
$
626,103

Operating income
 
202,319

 
1,490

 
3,251

 

 
207,060

 
 
 
 
 
 
 
 
 
 


Income before income taxes
 
$
150,549

 
$
1,490

 
$
3,251

 
$

 
$
155,290

Income tax provision
 
(37,828
)
 
(389
)
 
(853
)
 
(1,409
)
 
(40,479
)
Net income (loss)
 
$
112,721

 
$
1,101

 
$
2,398

 
$
(1,409
)
 
$
114,811

 
 
 
 
 
 
 
 
 
 
 
Diluted net income (loss) per share
 
$
4.50

 
$
0.04

 
$
0.11

 
$
(0.06
)
 
$
4.59

Diluted share count
 
25,028

 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2017
(Dollars in thousands, except per share amounts)
 
As reported
 
Insurance reserves
 
Acquisition expense
 
OEM settlement
 
Adjusted
Selling, general and administrative
 
$
500,062

 
$
(3,878
)
 
$
(2,137
)
 
$

 
$
494,047

Operating income
 
190,091

 
3,878

 
2,137

 

 
196,106

Other (expense) income, net
 
10,232

 

 

 
(9,111
)
 
1,121

 
 
 
 
 
 
 
 
 
 
 
Income (loss) before income taxes
 
$
169,099

 
$
3,878

 
$
2,137

 
$
(9,111
)
 
$
166,003

Income tax (provision) benefit
 
(65,172
)
 
(1,231
)
 
(821
)
 
3,423

 
(63,801
)
Net income (loss)
 
$
103,927

 
$
2,647

 
$
1,316

 
$
(5,688
)
 
$
102,202

 
 
 
 
 
 
 
 
 
 
 
Diluted net income (loss) per share
 
$
4.13

 
$
0.11

 
$
0.05

 
$
(0.23
)
 
$
4.06

Diluted share count
 
25,177

 
 
 
 
 
 
 
 

Liquidity and Capital Resources
We manage our liquidity and capital resources to fund our operating, investing and financing activities. We rely primarily on cash flows from operations and borrowings under our credit facilities or in capital markets as the main sources for liquidity. We use those funds to invest in capital expenditures, increase working capital and fulfill contractual obligations. Remaining funds are used for acquisitions, debt retirement, cash dividends, share repurchases and general business purposes.
 

38



Available Sources
Below is a summary of our immediately available funds:
 
 
As of June 30,
 
Increase (Decrease)
 
% Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
 
Cash and cash equivalents
 
$
29,991

 
$
31,177

 
$
(1,186
)
 
(3.8
)%
Available credit on the credit facilities
 
204,260

 
185,173

 
19,087

 
10.3

Total current available funds
 
234,251

 
216,350


17,901

 
8.3

Estimated funds from unfinanced real estate
 
222,439

 
192,067

 
30,372

 
15.8

Total estimated available funds
 
$
456,690

 
$
408,417


$
48,273

 
11.8
 %
 
Cash flows generated by operating activities and borrowings under our credit facility and other types of debt are our most significant sources of liquidity. We also have the ability to raise funds through mortgaging real estate. As of June 30, 2018, our unencumbered owned operating real estate had a book value of $297 million. Assuming we can obtain financing on 75% of this value, we estimate we could have obtained additional funds of approximately $222 million at June 30, 2018; however, no assurances can be provided that the appraised value of these properties will match or exceed their book values or that this capital source will be available on terms acceptable to us.
 
In addition to the above sources of liquidity, potential sources include the placement of subordinated debt or loans, the sale of equity securities and the sale of stores or other assets. We evaluate all of these options and may select one or more of them depending on overall capital needs and the availability and cost of capital, although no assurances can be provided that these capital sources will be available in sufficient amounts or with terms acceptable to us.
 
Information about our cash flows, by category, is presented in our Consolidated Statements of Cash Flows. The following table summarizes our cash flows:
 
 
Six Months Ended June 30,
 
Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
in Cash Flow
Net cash provided by operating activities
 
$
236,331

 
$
178,555

 
$
57,776

Net cash used in investing activities
 
(451,461
)
 
(125,219
)
 
(326,242
)
Net cash provided by (used in) financing activities
 
187,868

 
(72,441
)
 
260,309

 
Operating Activities
Cash provided by operating activities for the six months ended June 30, 2018 increased $57.8 million compared to the same period of 2017, primarily related to increases in other assets and accrued liabilities that were positively impacted by the recently enacted tax legislation and increases in floor plan notes payable and other long term liabilities, offset by a decrease in the change of accounts receivable compared to the same period of 2017.
 
Borrowings from and repayments to our syndicated lending group related to our new vehicle inventory floor plan financing are presented as financing activities. To better understand the impact of changes in inventory and the associated financing, we also consider our adjusted net cash provided by operating activities to include borrowings or repayments associated with our new vehicle floor plan credit facility.

Adjusted net cash provided by operating activities is presented below (in thousands):
 
 
Six Months Ended June 30,
 
Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
in Cash Flow
Net cash provided by operating activities – as reported
 
$
236,331

 
$
178,555

 
$
57,776

Add: Net borrowings (repayments) on floor plan notes payable, non-trade
 
85,763

 
(32,124
)
 
117,887

Less: Borrowings on floor plan notes payable, non-trade associated with acquired new vehicle inventory
 
(120,899
)
 

 
(120,899
)
Net cash provided by operating activities – adjusted
 
$
201,195


$
146,431


$
54,764



39



Inventories are the most significant component of our cash flow from operations. As of June 30, 2018, our new vehicle days supply was 77, or eight days higher than our days supply as of December 31, 2017. Our days supply of used vehicles was 62 days as of June 30, 2018, or five days lower than our days supply as of December 31, 2017. We calculate days supply of inventory based on current inventory levels, excluding in-transit vehicles, and a 30-day historical cost of sales level. We have continued to focus on managing our unit mix and maintaining an appropriate level of new and used vehicle inventory.
 
Investing Activities
Net cash used in investing activities totaled $451.5 million and $125.2 million, respectively, for the six-month periods ended June 30, 2018 and 2017. Cash flows from investing activities relate primarily to capital expenditures and acquisition and divestiture activity.
 
Below are highlights of significant activity related to our cash flows from investing activities:
 
 
Six Months Ended June 30,
 
Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
in Cash Flow
Capital expenditures
 
$
(72,373
)
 
$
(32,266
)
 
$
(40,107
)
Cash paid for acquisitions, net of cash acquired
 
(374,664
)
 
(88,075
)
 
(286,589
)
Cash paid for other investments
 
(7,066
)
 
(7,748
)
 
682

Proceeds from sales of stores
 
839

 

 
839


Capital Expenditures
Below is a summary of our capital expenditure activities:
 
 
Six Months Ended June 30,
(Dollars in thousands)
 
2018
 
2017
Post-acquisition capital improvements
 
$
31,095

 
$
7,304

Facilities for open points
 
6,202

 

Existing facility improvements
 
16,904

 
7,734

Maintenance
 
18,172

 
17,228

Total capital expenditures
 
$
72,373

 
$
32,266

 
Many manufacturers provide assistance in the form of additional incentives or assistance if facilities meet specified standards and requirements. We expect that certain facility upgrades and remodels will generate additional manufacturer incentive payments. Also, tax laws allowing accelerated deductions for capital expenditures reduce the overall investment needed and encourage accelerated project timeliness.
 
We expect to use a portion of our future capital expenditures to upgrade facilities that we recently acquired. This additional capital investment is contemplated in our initial evaluation of the investment return metrics applied to each acquisition and is usually associated with manufacturer standards and requirements. The increases in capital expenditures for the six-month period ended June 30, 2018, compared to the same period of 2017, relate primarily to upgrades of recently acquired facilities.

If we undertake a significant capital commitment in the future, we expect to pay for the commitment out of existing cash balances, construction financing and borrowings on our credit facility. Upon completion of the projects, we believe we would have the ability to secure long-term financing and general borrowings from third party lenders for 70% to 90% of the amounts expended, although no assurances can be provided that these financings will be available to us in sufficient amounts or on terms acceptable to us.

We expect to make expenditures of approximately $131 million in 2018 for capital improvements at recently acquired stores, purchases of land for expansion of existing stores, facility image improvements, purchases of store facilities, purchases of previously leased facilities and replacement of equipment.
 
Acquisitions
We focus on acquiring stores at attractive purchase prices that meet our return thresholds and strategic objectives. We look for acquisitions that diversify our brand and geographic mix as we continue to evaluate our portfolio to minimize exposure to any one manufacturer and achieve financial returns.
 

40



We are able to subsequently floor new vehicle inventory acquired as part of an acquisition; however, the cash generated by this transaction is recorded as borrowings on floor plan notes payable, non-trade.

Adjusted net cash paid for acquisitions, as well as certain other acquisition-related information is presented below:
 
 
Six Months Ended June 30,
 
 
2018
 
2017
Number of stores acquired
 
17

 
8

Number of stores opened
 

 
1

 
 
 
 
 
(Dollars in thousands)
 
 
 
 
Cash paid for acquisitions, net of cash acquired
 
$
374,664

 
$
88,075

Less: Borrowings on floor plan notes payable: non-trade associated with acquired new vehicle inventory
 
(120,899
)
 

Cash paid for acquisitions, net of cash acquired – adjusted
 
$
253,765

 
$
88,075

 
We evaluate potential capital investments primarily based on targeted rates of return on assets and return on our net equity investment.

Financing Activities
Net cash provided by or (used in) financing activities, adjusted for borrowing on floor plan facilities: non-trade was as follows:
 
 
Six Months Ended June 30,
 
Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
in Cash Flow
Cash provided by (used in) financing activities, as reported
 
$
187,868

 
$
(72,441
)
 
$
260,309

Adjust: Repayments (borrowings) on floor plan notes payable: non-trade
 
(85,763
)
 
32,124

 
(117,887
)
Cash provided by (used in) financing activities – adjusted
 
$
102,105

 
$
(40,317
)
 
$
142,422


Below are highlights of significant activity related to our cash flows from financing activities, excluding net borrowings on floor plan notes payable: non-trade, which are discussed above:
 
 
Six Months Ended June 30,
 
Increase (Decrease)
(Dollars in thousands)
 
2018
 
2017
 
in Cash Flow
Net borrowings (repayments) on lines of credit
 
$
99,163

 
$
(35,346
)
 
$
134,509

Principal payments on long-term debt and capital leases, unscheduled
 
(5,305
)
 
(35,765
)
 
30,460

Proceeds from issuance of long-term debt
 
62,140

 
74,065

 
(11,925
)
Repurchases of common stock
 
(33,927
)
 
(24,913
)
 
(9,014
)
Dividends paid
 
(13,938
)
 
(13,052
)
 
(886
)
  
Equity Transactions
On February 25, 2016, our Board of Directors authorized the repurchase of up to $250 million of our Class A common stock. We repurchased a total of 670,296 shares of our Class A common stock at an average price of $100.44 per share in the first six months of 2018. This included 640,586 shares as part of the repurchase plan at an average price per share of $99.89 and 29,710 shares related to tax withholding on vesting RSUs at an average price of $112.36 per share. As of June 30, 2018, we had $98.6 million remaining available for repurchases and the authorization does not have an expiration date.

In July 2018, we repurchased 226,910 shares at a weighted average price of $86.65 per share and, as of July 27, 2018, under our existing share repurchase authorization, $78.9 million remained available for share repurchases.

In December 2017, we entered into a structured repurchase agreement involving the use of capped call options for the purchase of our Class A common stock. As of June 30, 2018, the capped call options had expired and all outstanding options were settled.
 

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In the first six months of 2018, we declared and paid dividends on our Class A and Class B common stock as follows:
Dividend paid:
 
Dividend amount
per share
 
Total amount of dividend
(in thousands)
March 2018
 
$
0.27

 
$
6,759

May 2018
 
$
0.29

 
$
7,179

 
We evaluate performance and make a recommendation to the Board of Directors on dividend payments on a quarterly basis.
 
Summary of Outstanding Balances on Credit Facilities and Long-Term Debt
Below is a summary of our outstanding balances on credit facilities and long-term debt:
 
 
As of June 30, 2018
 
 
(Dollars in thousands)
 
Outstanding
 
Remaining Available
 
 
Floor plan note payable: non-trade
 
$
1,875,462

 
$

 
1 
Floor plan notes payable
 
142,606

 

 
 
Used vehicle inventory financing facility
 
50,000

 
85,000

 
2 
Revolving lines of credit
 
320,953

 
119,260

 
2, 3 
Real estate mortgages
 
642,602

 

 
  
5.25% Senior Subordinated Notes due 2025
 
300,000

 

 
 
Other debt
 
12,195

 

 
  
Total debt outstanding
 
3,343,818

 
204,260

 
 
Less: unamortized debt issuance costs
 
(6,575
)
 

 
 
Total debt
 
$
3,337,243

 
$
204,260

 
 
 
1 As of June 30, 2018, we had a $2.0 billion new vehicle floor plan commitment as part of our credit facility.
2 The amount available on the credit facility is limited based on a borrowing base calculation and fluctuates monthly.
3 Available credit is based on the borrowing base amount effective as of May 31, 2018. This amount is reduced by $9.7 million for outstanding letters of credit.

Credit Facility
Effective June 25, 2018, we amended our syndicated credit facility, now comprised of 20 financial institutions, including seven manufacturer-affiliated finance companies. Prior to this amendment, the credit facility, with an aggregate total financing commitment of $2.4 billion, would have matured in August 2022. With this amendment, the aggregate total financing commitment has been increased to $2.6 billion and the term of the credit facility has been extended to July 2023, among other changes.

The total commitment is allocated $135 million to used vehicle inventory floor plan financing, $450 million to revolving loans for acquisitions and other general corporate purposes, and the remaining $2.0 billion for new vehicle inventory floor plan financing. We have the option to reallocate the commitments, provided that the used vehicle inventory floor plan financing commitment does not exceed 16.5% of aggregate commitments, the revolving loan commitment does not exceed 18.75% of aggregate commitments, and the sum of these commitments plus the new vehicle inventory floor plan financing commitment does not exceed the aggregate total financing commitment of $2.6 billion. Additionally,we may request an increase in the aggregate new vehicle floor plan commitment of up to $400 million provided that the aggregate commitment does not exceed $3.0 billion. All borrowings from, and repayments to, our lending group are presented in the Consolidated Statements of Cash Flows as financing activities.

Our obligations under our revolving syndicated credit facility are secured by a substantial amount of our assets, including our inventory (including new and used vehicles, parts and accessories), equipment, accounts (and other rights to payment) and our equity interests in certain of our subsidiaries. Under our revolving syndicated credit facility, our obligations relating to new vehicle floor plan loans are secured only by collateral owned by borrowers of new vehicle floor plan loans under the credit facility.

We have the ability to deposit up to $50 million in cash in Principal Reduction (PR) accounts associated with our new vehicle inventory floor plan commitment. The PR accounts are recognized as offsetting credits against outstanding amounts on our new vehicle floor plan commitment and would reduce interest expense associated with the outstanding principal balance. As of June 30, 2018, we had no balances in our PR accounts.


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If the outstanding principal balance on our new vehicle inventory floor plan commitment, plus requests on any day, exceeds 95% of the loan commitment, a portion of the revolving line of credit must be reserved. The reserve amount is equal to the lesser of $15.0 million or the maximum revolving line of credit commitment less the outstanding balance on the line less outstanding letters of credit. The reserve amount will decrease the revolving line of credit availability and may be used to repay the new vehicle floor plan commitment balance.

The interest rate on the credit facility, as amended, varies based on the type of debt, with the rate of one-month LIBOR plus 1.25% for new vehicle floor plan financing, one-month LIBOR plus 1.50% for used vehicle floor plan financing and a variable interest rate on the revolving financing ranging from the one-month LIBOR plus 1.25% to 2.25% depending on our leverage ratio. The annual interest rate associated with our new vehicle floor plan commitment was 3.34% at June 30, 2018. The annual interest rate associated with our used vehicle inventory financing facility and our revolving line of credit was 3.59% at June 30, 2018.

Under the terms of our credit facility we are subject to financial covenants and restrictive covenants that limit or restrict our incurring additional indebtedness, making investments, selling or acquiring assets and granting security interests in our assets.

Under our credit facility, we are required to maintain the ratios detailed in the following table:
Debt Covenant Ratio
 
Requirement
 
As of June 30, 2018
Current ratio
 
Not less than 1.10 to 1
 
1.25 to 1
Fixed charge coverage ratio
 
Not less than 1.20 to 1
 
2.59 to 1
Leverage ratio
 
Not more than 5.00 to 1
 
3.52 to 1
 
As of June 30, 2018, we were in compliance with all covenants. We expect to remain in compliance with the financial and restrictive covenants in our credit facility and other debt agreements. However, no assurances can be provided that we will continue to remain in compliance with the financial and restrictive covenants.

If we do not meet the financial and restrictive covenants and are unable to remediate or cure the condition or obtain a waiver from our lenders, a breach would give rise to remedies under the agreement, the most severe of which are the termination of the agreement, acceleration of the amounts owed and the seizure and sale of our assets comprising the collateral for the loans. A breach would also trigger cross-defaults under other debt agreements.

Floor Plan Notes Payable
We have floor plan agreements with manufacturer-affiliated finance companies for new vehicles at certain stores and vehicles designated for use as service loaners. The variable interest rates on these floor plan notes payable commitments vary by manufacturer. At June 30, 2018, $142.6 million was outstanding on these arrangements. Borrowings from, and repayments to, manufacturer-affiliated finance companies are classified as operating activities in the Consolidated Statements of Cash Flows.
 
5.25% Senior Notes Due 2025
On July 24, 2017, we issued $300 million in aggregate principle amount of 5.25% Senior Notes due 2025 ("the Notes") to eligible purchasers in a private placement under Rule 144A and Regulation S of the Securities Act of 1933. Interest accrues on the Notes from July 24, 2017 and is payable semiannually on February 1 and August 1. The first interest payment was paid on February 1, 2018. We may redeem the Notes, in whole or in part, at any time prior to August 1, 2020 at a price equal to 100% of the principal amount plus a make-whole premium set forth in the Indenture and accrued and unpaid interest. After August 1, 2020, we may redeem some or all of the Notes subject to the redemption prices set forth in the Indenture. If we experience specific kinds of changes of control, as described in the Indenture, we must offer to repurchase the Notes at 101% of their principal amount plus accrued and unpaid interest to the date of purchase.

We paid $5.0 million of underwriting and other fees in connection with this issuance, which is being amortized as interest expense over the term of the Notes. The Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of our existing and future restricted subsidiaries that is a borrower under, or that guarantees obligations under, our credit facility or other indebtedness. The terms of the Notes, in certain circumstances, may restrict our ability to, among other things, incur additional indebtedness, pay dividends, repurchase our common stock, or merge, consolidate or sell all or substantially all our assets.

We used the net proceeds for general corporate purposes, which included funding acquisitions, capital expenditures, and debt repayment.


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Real Estate Mortgages and Other Debt
We have mortgages associated with our owned real estate. Interest rates related to this debt ranged from 3.0% to 5.3% at June 30, 2018. The mortgages are payable in various installments through 8/1/2038. As of June 30, 2018, we had fixed interest rates on 70% of our outstanding mortgage debt.
 
Our other debt includes capital leases and sellers’ notes. The interest rates associated with our other debt ranged from 3.1% to 8.0% at June 30, 2018. This debt, which totaled $12.2 million at June 30, 2018, is due in various installments through December 2050.

Recent Accounting Pronouncements
See Note 12 of the Condensed Notes to Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
 
Critical Accounting Policies and Use of Estimates
There have been no material changes in the critical accounting policies and use of estimates described in our 2017 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 23, 2018.

See also Notes 2 and 13 of the Condensed Notes to Consolidated Financial Statements in this Quarterly Report on Form 10-Q for additional information including the impact of our January 1, 2018 adoption of accounting standards update ("ASU") 2014-09 "Revenue from Contracts with Customers."

Seasonality and Quarterly Fluctuations
Historically, our sales have been lower in the first quarter of each year due to consumer purchasing patterns and inclement weather in certain of our markets. As a result, financial performance is expected to be lower during the first quarter than during the second, third and fourth quarters of each fiscal year. We believe that interest rates, levels of consumer debt, consumer confidence and manufacturer sales incentives, as well as general economic conditions, also contribute to fluctuations in sales and operating results.
 
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
There have been no material changes in our reported market risks or risk management policies since the filing of our 2017 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on February 23, 2018.

Item 4. Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
We evaluated, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure and that such information is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
 
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.


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PART II - OTHER INFORMATION
 
Item 1. Legal Proceedings

We are party to numerous legal proceedings arising in the normal course of our business. Although we do not anticipate that the resolution of legal proceedings arising in the normal course of business will have a material adverse effect on our business, results of operations, financial condition, or cash flows, we cannot predict this with certainty.

Item 1A. Risk Factors
 
There have been no material changes from the risk factors previously disclosed in our 2017 Annual Report on Form 10-K. The information in this Form 10-Q should be read in conjunction with the risk factors and information disclosed in that report, which was filed with the Securities and Exchange Commission on February 23, 2018.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
We repurchased the following shares of our Class A common stock during the second quarter of 2018:
 
 
Total number of shares purchased 2
 
Average price paid per share
 
Total number of shares purchased as part of publicly announced plans 1
 
Maximum dollar value of shares that may yet be purchased under publicly announced plan (in thousands) 1
April
 
229,826

 
$
96.77

 
229,826

 
$
135,366

May
 
35,925

 
95.00

 
35,760

 
131,969

June
 
325,000

 
102.76

 
325,000

 
98,573

 
 
590,751

 
$
99.96

 
590,586

 
$
98,573

 
1 Effective February 29, 2016, our Board of Directors authorized the repurchase of up to $250 million of our Class A common stock. This authorization does not have an expiration date and it replaced the previous authorizations, which limited the number of shares we were authorized to repurchase.
2 Of the shares repurchased in the second quarter of 2018, 165 shares were related to the tax withholdings on vesting RSUs.


45



Item 6. Exhibits
 
The following exhibits are filed herewith and this list is intended to constitute the exhibit index.
3.1
Restated Articles of Incorporation of Lithia Motors, Inc., as amended May 13, 1999 (incorporated by reference to
exhibit 3.1 to our Form 10-K for the year ended December 31, 1999).
2017 Amended and Restated Bylaws of Lithia Motors, Inc. (incorporated by reference to exhibit 3.1 to Form 8-K dated April 28, 2017 and filed with Securities and Exchange Commission on May 3, 2017).
Indenture, dated as of July 24, 2017, among Lithia Motors, Inc., the Guarantors and the Trustee (incorporated by reference to exhibit 4.1 to Form 8-K dated July 24, 2017 and filed with the Securities and Exchange Commission on July 24, 2017).
Form of 5.250% Senior Notes due 2025 (included as part of Exhibit 4.1)(incorporated by reference to exhibit 4.1 to Form 8-K dated July 24, 2017 and filed with the Securities and Exchange Commission on July 24, 2017).
Second Amended and Restated Loan Agreement (incorporated by reference to exhibit 10.1 to Form 8-K dated June 25, 2018 and filed with the Securities and Exchange Commission on June 29, 2018).
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934.
Certification of Chief Executive Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
Certification of Chief Financial Officer pursuant to Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.

46



SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: July 27, 2018
LITHIA MOTORS, INC.
 
 
 
By: /s/ John F. North III
 
John F. North III
 
Senior Vice President and Chief Financial Officer
 
(Duly Authorized Officer and Principal Financial and
 
Accounting Officer)

47